Break Even Analysis with an Example

The break-even analysis is used to find the number of products your company needs to produce to cover all the expenses before it makes a profit.

As I mentioned before, I will be expanding the range of this blog to cover more business topics that could be useful for developers or startups. Therefore, I will be covering not only web design or web development topics. But, software development in general, business, finance, project management, product management, etc. Today I would like to start with Break Even Analysis which is essential for anyone that has to do business because it tells when we are making enough money to pay for our expenses.

The break-even analysis is used to find the number of products your company needs to produce to cover all the expenses before it makes a profit. This allows managers to know the minimum target revenue because, after that amount, everything is profit while everything before is a loss (Marshall et al., 2011). The break-even point is where revenues and costs meet in the graph and the profit or loss is equal to zero (Nickels et al., 2016). This method is very useful not only for managers but for business and system analysts to determine if a project is worth pursuing considering the costs and revenue involved in the project.

Example of Break-Even Analysis

Supposed that James Mark has a web design company that creates WordPress sites. The company charges $7,000 for a website. Each website costs around $3,000 to make and the company has $16,000 in fixed costs. How many websites does James’ company need to build to break even?

Before we find the number of websites needed, it is important to define the following terms:

Fixed costs: The type of costs that don’t change no matter the number of websites produced by the company. For example, the rent of the building needs to be paid monthly even if the company did not create a website during the entire month.

Variable cost per unit: it is the cost of creating one of the websites. The average costs must be zero if the company did not develop a website for a month. However, we know that the average cost for a website is $3000 based on our example.

Price per unit: is how much the company changes per website. In this case, the company charges $7,000.

Now, based on the previous information we can calculate the break-even point with the formula:

Break-even = Fixed Costs / (price per unit – variable cost per unit)

Break-even = $16,000 / ($7,000 – $3,000)

Break-even = $16,000/ $4,000 = 4

So, the company needs to make at least 4 websites a month to cover the expenses (or break-even). In this case, they at least have to create five websites a month to make a profit. If they make 3 websites, they will not cover the costs and will be losing money.

References

Marshall, D. H., Viele, D. F., & Mcmanus, W. W. (2011). Accounting: What the Numbers Mean. Mcgraw-Hill Irwin.
Nickels, W. G., Mchugh, J. M., & Mchugh, S. M. (2016). Understanding Business (11th ed.). Mcgraw-Hill Education.