Break-Even Analysis

The material focuses on a specific management technique that is used

widely in business to determine the expected profitability at various sales levels. This technique

is called break-even analysis and is widely accepted for two pragmatic reasons: its

straightforward assumptions and the usefulness of the information provided. The bottom line is

that in many cases this approach works.

The Objective and Uses of Break-Even Analysis

The objective of break-even analysis is to determine the break-even quantity of output (the

quantity point at which the total revenues received just equal the total expenses incurred) by

studying the relationships among the firm’s cost structure, volume of output, and operating profit.

More specifically, the break-even quantity of output is the quantity of output (in units) that

results in an EBIT level equal to zero. The use of the break-even model enables the financial

officer to answer two critical questions: (1) What is the minimum quantity of output that must be

sold to cover all operating costs—that is, to break even—and (2) what will be the expected

EBIT, or operating income, at various levels of output above and below the break-even point?

Some of the major applications of break-even analysis are:

• setting product-pricing policy

• determining the effects of labor contract provisions

• evaluating competitive and comparative price-cost structures.

• making financial decisions