Break even analysis

The breakeven point for a product, brand, or company is the point where total revenue equals total costs (TR=TC). At a price or quantity greater than this point, the firm is making a profit ; below this point, a loss. It is calculated by:

Total fixed costs / (price - average variable costs)

It is particularly useful in comparing the profit consequences of alternative prices. By inserting different prices into the formula, you will obtain a number of break even points.

To make the results clearer, they are usually graphed. You first draw the cost curves (TC and FC in the diagram). Then calculate the break even points (A,B,C) and plot them on the total cost curve (TC). Drawing a line from the origin through a break even point will produce a linear total revenue curve (like R1, R2, and R3).

Limitations

• This is only a supply side (ie.: costs only) analysis.
• It tells you nothing about whether you can actually sell the product at these prices.
• It assumes that fixed costs (FC) are constant
• It assumes variable costs are constant per unit of output

See also : cost-plus pricing, pricing, production, costs, and pricing

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