Break-Even Analysis – Fundamentals
Break-even analysis is a managerial (cost) accounting tool used to examine the relationship of price to cost of a product. It also considers various sales volumes and the effect on profit given the different relationships of price to cost. The break-even analysis is an essential tool in maximizing profit with the least amount of resources. It goes much further by defining the minimum production necessary to cover (pay) fixed costs at various sale prices. Naturally the higher the sales price the sooner fixed costs are covered with production.
This article explains the sales price to cost relationship. The impact of sales volume and how it affects total profit is expounded upon in Break-Even Analysis – Sales Volume and Profit on this website. To grasp the fundamentals of break-even analysis the reader must first understand some basic terms used in cost accounting including:
1) Fixed Costs
2) Variable Costs
3) Sunk Costs
5) Contribution Margin
Secondly, a break-even point is explained and evaluated at different sale prices (price points) and the corresponding contribution margin is determined. Finally a comprehensive example along with an outcome table is derived with insights in assessing the results. Once the fundamentals are understood the reader can now evaluate simple and basic single item break-even analysis.
There are hundreds of terms used in cost accounting but a few terms are synonymous with cost accounting and they include