Lesson 31 - Intermediate Accounting Course 

31. Break-even Analysis and Contribution Margin

Understanding how costs, pricing, and sales volume interact is critical for any business. Break-even analysis and contribution margin are two fundamental tools used to determine when a company will start making a profit and how changes in costs or prices impact profitability.

1️⃣ What Is Break-even Analysis?

Break-even analysis helps businesses determine the point at which total revenue equals total costs—in other words, when a company is neither making a profit nor incurring a loss. This point is called the break-even point (BEP).

Why Is Break-even Analysis Important?

✔ Helps businesses set sales targets to achieve profitability.
✔ Assists in pricing decisions to ensure the price covers costs.
✔ Identifies how cost structure impacts profitability.
✔ Useful for evaluating new product launches or business expansions.

Break-even Formula

The break-even point in units is calculated using the formula:

Where:

• Fixed Costs = Costs that do not change with production (e.g., rent, salaries).
  
  

• Variable Costs = Costs that change with production (e.g., raw materials, commissions).
  
  

• Selling Price per Unit = The price at which each unit is sold.

2️⃣ Contribution Margin: The Key to Break-even Analysis

The Contribution Margin (CM) represents how much revenue from each unit contributes toward covering fixed costs and generating profit.

Formula for Contribution Margin (per unit):

✔ If CM is high, fewer sales are needed to cover fixed costs.
✔ If CM is low, the company must sell more units to break even.

Contribution Margin Ratio:

This ratio tells us what percentage of sales revenue is available to cover fixed costs and generate profit.

3️⃣ Example of Break-even Calculation

A company sells laptops at $1,000 per unit.

• Fixed Costs = $50,000 (rent, utilities, salaries).
  
  

• Variable Cost per Unit = $600 (components, labor, packaging).
  
  

Step 1: Calculate Contribution Margin

Step 2: Calculate Break-even Point 

💡 The company must sell 125 laptops to cover all costs and break even. 

4️⃣ Break-even Analysis with Profits

If a company wants to make a target profit, we modify the formula:

Example: Target Profit Calculation

If the company wants to earn a $20,000 profit, the required sales volume is:

💡 The company must sell 175 units to reach a $20,000 profit. 

5️⃣ Break-even Analysis in Dollars

Instead of calculating the break-even point in units, we can calculate the break-even revenue using the contribution margin ratio:

Using our laptop example: 

💡 The company must generate $125,000 in revenue to break even.

6️⃣ Impact of Cost and Price Changes on Break-even Point

✔ What If Fixed Costs Increase?

• The break-even point increases because more units are needed to cover costs.
  
  

• Example: If fixed costs rise from $50,000 to $60,000, the new break-even point is:

✔ What If Selling Price Increases?

• The contribution margin increases, lowering the break-even point.
  
  

• Example: If the price rises to $1,200 (CM = $600), the break-even point is:

✔ What If Variable Costs Increase?

• The contribution margin decreases, raising the break-even point.
  
  

• Example: If variable costs increase to $700 per unit (CM = $300), the break-even point is:

7️⃣ Limitations of Break-even Analysis

🔴 Assumes costs and revenues are constant—in reality, economies of scale or market demand fluctuations can alter costs.
🔴 Does not consider time value of money—useful for short-term planning, but long-term decisions require discounted cash flow analysis.
🔴 Ignores external factors—competition, economic conditions, and consumer behavior can impact actual break-even performance.

8️⃣ Summary & Key Takeaways

✔ Break-even analysis determines the sales volume needed to cover all costs.
✔ The Contribution Margin is crucial in calculating the break-even point.
✔ Higher fixed costs increase the break-even point, while higher prices or lower variable costs reduce it.
✔ Companies use break-even analysis for pricing strategy, cost control, and profitability planning.

Break-even analysis is a powerful financial tool that helps businesses make informed pricing, cost-cutting, and investment decisions.