A breakeven analysis is used to determine how much sales volume your business needs to start making a profit.
The breakeven analysis is especially useful when you're developing a pricing strategy, either as part of a marketing plan or a business plan.
To conduct a breakeven analysis, use this formula:
Fixed Costs divided by (Revenue per unit - Variable costs per unit)
Fixed costs are costs that must be paid whether or not any units are produced. These costs are "fixed" over a specified period of time or range of production.
Variable costs are costs that vary directly with the number of products produced. For instance, the cost of the materials needed and the labour used to produce units isn't always the same.
For example, suppose that your fixed costs for producing 100,000 widgets were $30,000 a year.
Your variable costs are $2.20 materials, $4.00 labour, and $0.80 overhead, for a total of $7.00.
If you choose a selling price of $12.00 for each widget, then:
$30,000 divided by ($12.00 - 7.00) equals 6000 units.
This is the number of widgets that have to be sold at a selling price of $12.00 before your business will start to make a profit.