Break-Even Point
What it is:
How it works (Example):
The basic idea behind break-even point is to calculate the point at which revenues begin to exceed costs.
The first step is to separate a company's costs in to those that are variable and those that are fixed. Fixed costs are costs that do not change with the quantity of output. Examples of Fixed cost include rent, insurance premiums, or loan payments. Variable costs are costs that change with the quantity of output. They are zero when production is zero. Examples of common variable costs include labor directly involved in a company's manufacturing process and raw materials.
For example, at XYZ Restaurant, which sells only pepperoni pizza, the variable expenses per pizza are:
| Fixed Costs | Variable Costs | ||
| General Labor | $1,500 | Flour | $0.50 |
| Rent | $3,000 | Yeast | $0.05 |
| Insurance | $200 | Water | $0.01 |
| Advertising | $500 | Cheese | $3.00 |
| Utitilies | $450 | Pepperoni | $2.00 |
| Total | $5,650 | Total | $5.56 |
It is important to note that some fixed costs increase "stepwise," meaning that after a certain level of revenue is reached, the fixed cost changes. For example, if XYZ Restaurant began selling 5,000 pizzas per month rather than just 2,000, it might need to hire a second manager, thus increasing labor costs.
