Breakeven analysis entails the calculation and examination of the margin of safety for an entity based on the revenues collected and associated costs. Analyzing different price levels relating to various levels of demand, a business uses breakeven analysis to determine what level of sales are necessary to cover the company’s total fixed costs. A demand-side analysis would give a seller significant insight regarding selling capabilities.
Breakeven analysis is useful in the determination of the level of production or a targeted desired sales mix. The study is for management’s use only, as the metric and calculations are not necessary for external sources such as investors, regulators or financial institutions. This type of analysis depends on a calculation of the breakeven point (BEP). The breakeven point is calculated by dividing the total fixed costs of production by the price of a product per individual unit less the variable costs of production. Fixed costs are those which remain the same regardless of how many units are sold.
Breakeven analysis looks at the level of fixed costs relative to the profit earned by each additional unit produced and sold. In general, a company with lower fixed costs will have a lower breakeven point of sale. For example, a company with $0 of fixed costs will automatically have broken even upon the sale of the first product assuming variable costs do not exceed sales revenue. However, the accumulation of variable costs will limit the leverage of the company as these expenses come from each item sold.