Disadvantages and Advantages of Break-Even Analysis - ToughNickel - Money
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Disadvantages and Advantages of Break-Even Analysis

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I'm a longtime writer with a long history of writing about business and business management.

Read on to learn how a break-even analysis can help you better understand business.

Read on to learn how a break-even analysis can help you better understand business.

What Is Break-Even Analysis?

Break-even analysis is the relationship between cost volume and profits at various levels of activity, with an emphasis placed on the break-even point. This point is where the business receives neither a profit nor a loss, when total money received from sales is equal to total money spent to produce the items for sale.

An example of a break-even analysis.

An example of a break-even analysis.

Advantages and Uses

Break-even analysis enables a business organization to:

  1. Measure profit and losses at different levels of production and sales.
  2. Predict the effect of changes in sales prices.
  3. Analyze the relationship between fixed and variable costs.
  4. Predict the effect of cost and efficiency changes on profitability.

Disadvantages

Even with its advantages and uses, there are also several demerits of break-even analysis.

  1. Assumes that sales prices are constant at all levels of output.
  2. Assumes production and sales are the same.
  3. Break even charts may be time consuming to prepare.
  4. It can only apply to a single product or single mix of products.

Formulas

There are two ways to calculate the break-even point, in units and in sales revenue.

  1. The first way is to divide the fixed cost by the contribution per unit. This gives the result in units.
  2. Divide the fixed cost by the contribution-to-sales ratio. This gives the sales revenue.The contribution-to-sales ratio is given by dividing the contribution per unit by the selling price per unit.

Example of a Break-Even Point

ABC Ltd expects to sell 10,000 units at $10 each. The variable cost per unit is $5 and the fixed cost is $15,000 per annum. Calculate the break even point in units and in sale revenue.

  • To calculate the break-even point in units, use the formula-fixed cost divided by the contribution per unit. In this example you would divide $1,000 by contribution (which is the selling price of $10 minus the variable cost per unit of $5). $15,000 divided by $5 is 3000 units
  • To calculate the break-even point in sales revenue, divide the fixed cost by the contribution-to-sales ratio. In this example, $15,000 divided by ($5 divided by $10, or .5). The final answer is $30,000. We know this is the correct answer because when we multiply the break-even point in units by the selling price, we get the same answer.

Business Example:

Fictional Company 

Unit selling price:

$36

Unit variable expenses:

$28

Total fixed expenses:

$50,000

Actual sales:

7,000 units

A break-even chart is a graphical representation of the break-even point, profits, losses and margin of safety. Using information from the example above, we will create a chart that shows:

  • fixed cost
  • total revenue line
  • margin of safety
  • loss region
  • total cost line
  • break-even point
  • profit region
  1. Work out the total revenue by multiplying the unit selling price by the actual sales: 36 × 7,000 = 252,000
  2. Work out the total cost by multiplying the unit variable expenses by the number of units sold and adding that to to the fixed expenses: 28 × 7,000 = 196,000 + 50,000 = 246,000
  3. Now set up your chart. Note that when plotting, the first number in brackets is the x (horizontal) axis value and the second digit after the comma is the y (vertical) axis value. For this chart, you will show total unit sales along the x axis in thousands. Along the y axis you will show sales in tens of thousands of dollars, since there were 7,000 units sold and $50,000 in total sales.
  4. Now draw the fixed cost line. Make a dotted line from (0, 50,000) to (7,000, 50,000).
  5. Next you will make the Total Revenue line. Plot a point at (7,000, 252,000) and draw a line from zero to that point. Label the line.
  6. To create the Total Cost line, plot the point (7,000, 246,000) and draw a line from (0, 50,000) to that point. Label the line.
  7. Where the two lines meet is called the Break-Even Point and should to be labeled as such. The region below the break-even point should be labeled the Loss Region. The region above the break-even point should be labeled the Profit Region.
  8. Draw a dotted line from the break-even point to meet the x axis. From where it touches the x axis, to the actual sales, is the Margin of Safety in Units.
  9. To illustrate the margin of safety in dollars, draw a dotted line from the break-even point to the y axis. From where the line touches the y axis, to the total revenue line, is the Margin of Safety in Dollars.
The finished chart showing a break-even analysis for a fictional company.

The finished chart showing a break-even analysis for a fictional company.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

Comments

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charles on February 11, 2019:

this is such a good guide on how this thing works i was able to do my business because of you and this article

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abdi big head on December 13, 2018:

so goo

Name on November 15, 2018:

thanks, this helped me in my business work :D

Thanks. on October 04, 2018:

Thanks.

meera on May 26, 2018:

how can we do the chart

devvo1 on May 24, 2018:

if you want some i will give it ya

SparklyBubble on March 15, 2018:

You haven't really explained the advantages or disadvantages that well.

Thanks Thanks thanks I'm greatful on March 13, 2018:

It was very much helpful

Welikhe Geofrey on March 04, 2018:

Thanks Very good

prayer on February 16, 2018:

helped a lot .thanks hey

Sofia Dotkova on January 30, 2018:

Farkhan is the best let me sit here !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

Chamali on January 29, 2018:

Why breakeven analysis can work only for single product

jimmy on January 25, 2018:

cheers jeff

hello, is it me you're looking for? on January 11, 2018:

coudn't you say advantages better?

varun kumar jain on November 27, 2017:

awsome thing

anonymous on October 04, 2017:

i don't really understand the advantages

bleesing tylor on June 27, 2017:

helped on hw to calculate breakeven

bob on May 24, 2017:

helped in my business lesson

byabashaija emmanuel on September 22, 2016:

i have learnt how to plan for a certain company

GODFREY GASIGWA on September 21, 2016:

Thanks alot its so interesting and it helps us as students to pass course works

rojj on August 13, 2016:

is very useful for me thank u sooo much

hussain on May 10, 2016:

nice

mathslover (author) from Barbados on October 19, 2015:

Thanks @kumar

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Thankxx god ... it is useful for writing in the exam like chit

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excellent- u saved my life- i got a job because of this

mathslover (author) from Barbados on February 26, 2015:

Thanks vybz

mathslover (author) from Barbados on February 26, 2015:

Thanks vybz

vybz on February 26, 2015:

good stuff

Ted Smith on January 06, 2015:

I really like this break even analysis. It really helps you see how much profit you are making or how much money you are losing. I should do this with my business. I might need to have an accountant help me though. I'm not the best at math.

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tatie mcgee on June 26, 2014:

thanks buh I nid limitations

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moses j on June 09, 2014:

what is the disadvantage of break even

iq on June 06, 2014:

Thanks a lot .what I have learn here would surely enable me have an A grade in my course

mathslover (author) from Barbados on April 18, 2014:

thank u very much @ csmiravite-blogs

Consolacion Miravite from Philippines on April 13, 2014:

Breakeven analysis is a fairly easy concept to understand. It is harder to learn in school than to apply it in actual work situations. What this just means is that --- at what level of sales do you need to recoup all your expenses? Say, if your total cost/expenses amounts to $10 and your unit sales price is $2 ----- BEP (Breakeven point) is 5 units. Meaning, after selling 5 units, all incremental sales would be profit.

This is a big help in business. Especially the small trade stores and outlets that does not have much financial muscle. Good hub!

GUD JOB BRO on June 03, 2013:

BUT THERE IS ANOTHER DISADVANTAGE AND ITS THAT:

Break even charts are constructed assuming that all goods produced by the firm is actually sold - the graph does not show the possibility that stocks may build up if not all goods are sold

zolah on May 13, 2013:

thanx a lot

TAHA on March 26, 2013:

ITS RUBBISH

MTALHAASIF on March 26, 2013:

Your knowledge is highly appreciated . THANKS A LOT

cj on February 01, 2013:

thank you so much guys didn't know about the limitations of breakeven analysis nd diddnt know that it has some merits and demerits......thank you so much now i understand so much bout da topic

MOZIEY OBY CHINS on October 30, 2012:

THANX GUYZ

MOZIEY OBY CHINS on October 30, 2012:

THANX GUYZ

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mathslover (author) from Barbados on June 14, 2012:

you are welcome!!

Rabion on June 14, 2012:

Thank u for work,it helped me a lot.

pep on May 04, 2012:

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ana on March 21, 2012:

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ussy on February 24, 2012:

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BizVT34 from USA on February 21, 2012:

Good stuff on break-even. However, I like to pair it with a cash flow forecast. I'v seen many businesses that were break-even go bankrupt because they run out of cash. Here's a 30 Second biz lesson on cash flow https://hubpages.com/business/Cash-Flow-vs-Profit...

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rahyan rasool on January 30, 2012:

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Stanley Relson on November 10, 2011:

Thankyou very much for the valueable information. i now know that the breakeven point is the point at which the revenue and the cost lines intersects. moreover i now the adventages and the dis adventages that it has.

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ii like all these information about breakeven point from love singh sikarwar lucknow, BBA student contect no 07860529428

mathslover (author) from Barbados on March 14, 2011:

Thanks a lot crystolite i am glad you have taken some knowledge from this hub with you.

Emma from Houston TX on March 14, 2011:

thanks for telling me about Breakeven analysis I now know that is all about calculation and also had advantage and disadvantages.