Businesses use economic resources in order to set up, operate and expand activities intended to produce revenues. Such revenues are produced through incurring expenses and economic obligations to entities other than the business. In cases where revenues exceed expenses, the business has made a net income or a gain in its financial circumstances; in contrast in cases where expenses exceed revenues, the business has made a net loss. Break-even is a method used to determine the threshold at which nonprofitability becomes profitability.
Break-even method is a supply-side analysis used to better understand a business or a project's profitability. Supply-side means that it is concerned with variables that originate in the producers' side of the consumer-producer relationship, variables such as units produced rather than units sold. This limits how useful a break-even method can be in understanding the big picture but does not restrict its usefulness in understanding the business' profitability in the short term and on the small scale.
Break-even analysis is used to calculate the point at which a specific measurement of revenues is equal to a specific measurement of costs. In cases where revenues are higher than costs, the business is profitable and desirable, whereas where costs are higher than revenues, the business is unprofitable and thus undesirable. In general, the higher the break-even point calculated, the riskier the business is estimated to be.
Accounting break-even method is the most common form of the analysis done and one of the easiest. It is calculated as being the number of units that need to be sold in order to produce zero profit. More formally, the number of units required can be calculated as total fixed cost divided by the difference between unit price and variable cost. The difference between unit price and variable cost can be considered the profit per unit produced and sold and a business must sell enough units to cover its fixed costs before it can become profitable.
Financial break-even is a similar concept to accounting break-even but uses very different measurements. It is the level of earnings needed before a firm's earnings per share is equal to zero. Here, earnings is defined as earnings before interest and taxes, or gross profit minus cost of sales and operating expenses and earnings per share is most often defined as being earnings divided by the number of outstanding common shares.
