Break-even analysis is a technique for finding the level of sales at which a business's total revenue exactly equals its total costs, so that it earns zero profit. The result of the analysis is the break-even point, which has its own entry covering the formulas and limitations in detail. Break-even analysis is the wider process of calculating that point and using it to test plans, prices and costs.
How break-even analysis is used
The analysis separates costs into fixed costs and variable costs. The break-even volume equals fixed costs divided by the contribution margin per unit, which is selling price minus variable cost per unit. A café with fixed costs of $9,000 a month, selling coffee at $4.50 with variable costs of $1.50 a cup, earns $3.00 of contribution per cup and breaks even at 3,000 cups a month.
Managers use break-even analysis to judge whether a new product or location is realistic, to see how much sales could fall before losses begin, known as the margin of safety, and to compare options such as raising prices or cutting costs. It is part of the broader framework of cost-volume-profit analysis, which also calculates the sales needed for a target profit. The analysis assumes that prices and unit costs stay constant within the relevant range of activity, that all output is sold and that the sales mix does not change, so results should be treated as estimates and revisited when conditions change.