Break even analysis

Break-even point analysis is a measurement system that calculates the margin of

safety by comparing the amount of revenues or units that must be sold to cover
fixed and variable costs associated with making the sales. In other words, its a
way to calculate when a project will be profitable by equating its total revenues
with its total expenses. There are several different uses for the equation, but all of
them deal with managerial accounting and cost management.
The main thing to understand in managerial accounting is the difference between
revenues and profits. Not all revenues result in profits for the company. Many
products cost more to make than the revenues they generate. Since the expenses
are greater than the revenues, these products great a lossnot a profit.
The purpose of the break-even analysis formula is to calculate the amount of sales
that equates revenues to expenses and the amount of excess revenues, also known
as profits, after the fixed and variable costs are met. There are many different ways
to use this concept. Lets take a look at a few of them as well as an example of how
to calculate break-even point.

Formula
The break-even point formula is calculated by dividing the total fixed costs of
production by the price per unit less the variable costs to produce the product.

Since the price per unit minus the variable costs of product is the definition of
the contribution margin per unit, you can simply rephrase the equation by dividing
the fixed costs by the contribution margin.
This computes the total number of units that must be sold in order for the company
to generate enough revenues to cover all of its expenses. Now we can take that
concept and translate it into sales dollars.
The break-even formula in sales dollars is calculated by multiplying the price of
each unit by the answer from our first equation.

This will give us the total dollar amount in sales that will we need to achieve in
order to have zero loss and zero profit. Now we can take this concept a step further
and compute the total number of units that need to be sold in order to achieve a
certain level profitability without break-even calculator.
First we take the desired dollar amount of profit and divide it by the contribution
margin per unit. The computes the number of units we need to sell in order to
produce the profit without taking in consideration the fixed costs. Now we must
add back in the break-even point number of units. Heres what it looks like.

Example
Lets take a look at an example of each of these formulas. Barbara is
the managerial accountant in charge of a large furniture factorys production lines
and supply chains. She isnt sure the current years couch models are going to turn
a profit and what to measure the number of units they will have to produce and sell
in order to cover their expenses and make at $500,000 in profit. Here are the
production stats.
Total fixed costs: $500,000
Variable costs per unit: $300
Sale price per unit: $500
 Desired profits: $200,000
First we need to calculate the break-even point per unit, so we will divide the
$500,000 of fixed costs by the $200 contribution margin per unit ($500 $300).

As you can see, the Barbaras factory will have to sell at least 2,500 units in order
to cover its fixed and variable costs. Anything it sells after the 2,500 mark will go
straight to the CM since the fixed costs are already covered.
Next, Barbara can translate the number of units into total sales dollars by
multiplying the 2,500 units by the total sales price for each unit of $500.

Now Barbara can go back to the board and say that the company must sell at least
2,500 units or the equivalent of $1,250,000 in sales before any profits are realized.
She can also take it a step further and use a break-even point calculator to compute
the total number of units that must be produced in order to meet her $200,000
profitability goal by dividing the $200,000 desired profit by the contribution
margin then adding the total number of break-even point units.

These are just examples of the break-even point. You can use these as a template
for your business or course work.
What is 'Scarcity'

Scarcity refers to the basic economic problem, the gap between limited that is,
scarce resources and theoretically limitless wants. This situation requires people
to make decisions about how to allocate resources efficiently, in order to satisfy
basic needs and as many additional wants at possible. Any resource that has a non-
zero cost to consume is scarce to some degree, but what matters in practice is
relative scarcity.

What is the 'Scarcity Principle'

The scarcity principle is an economic principle in which a limited supply of a
good, coupled with a high demand for that good, results in a mismatch between the
desired supply and demand equilibrium. In pricing theory, the scarcity principle
suggests that the price for a scarce good should rise until an equilibrium is reached
between supply and demand. However, this would result in the restricted exclusion
of the good only to those who can afford it. If the scarce resource happens to be
grain, for example, individuals will not be able to attain their basic needs.

BREAKING DOWN 'Scarcity Principle'

When a product is scarce, consumers are faced with conducting their own cost-
benefit analysis, since a product in high demand but low supply will likely be
expensive. This means that the consumer should only take action and purchase the
product if he or she sees a greater benefit from having the product than the cost
associated with obtaining it.

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