Two Methods of Breakeven Analysis
We can represent the breakeven level in two ways:
- The number of units we need to sell to breakeven
- The amount of sales that we need to generate to breakeven
For example, a company could say that it needs to sell 2,500 units to breakeven, or it could say that it needs to generate $15,000 in sales to break even.
To calculate breakeven in terms of units, you take your fixed costs and then divide them by the contribution margin per unit. For our example, we know that the contribution margin per unit is $4, and let’s say the fixed costs are $10,000. We simply divide our fixed costs of $10,000 by the contribution margin per unit, which is $4. The total is 2,500 units ($10,000 / $4). We need to sell 2,500 units to break even.
We know that we need to sell 2,500 units and each unit sells for $6. Our breakeven point in the amount of sales is $15,000 (2,500 X $6). Now, there is another way to measure breakeven in sales dollars amount, and that involves what is called the contribution margin ratio. So far, we’ve shown that our contribution margin is $4.
Now, if we wanted to express this as a ratio, we would take the contribution margin and divide it by the sales per unit amount ($4/$6). The contribution margin ratio is 0.67, and this means that for every $1 of sales, we have $0.67of contribution margin. In other words, it means that we spend $0.33** on the variable costs.
As another example, let’s say that we have fixed costs of $35,000. And our contribution margin ratio is 0.4. How much in sales do we need to generate to break even? Since we’re given the contribution margin ratio, we don’t need to know the sales price per unit or the variable cost per unit. Instead, we take the $35,000 fixed costs and divide it by the contribution margin ratio of 0.4, which is $87,500. That means that we need to generate $87,500 worth of sales in order to break even.