Accounting and Finance Foundations

Unit 11

Accounting and Finance Foundations Unit 11: Financial Analysis 848

Financial Analysis

Lesson 24.1

Certified public accountants (CPAs) provide insight into business performance through other types of

analysis in addition to financial-statement analysis. The following lesson will look at break-even point, cost,

and productivity analyses.

Break-Even Analysis

When planning their operations, firms must decide:

n    How many units they expect to sell

n    How many units they expect to produce (or purchase from suppliers)

n    How much they need to spend to produce/purchase and sell these units

n    The price at which they should sell the units to make the profit they want

To make these decisions, firms must calculate their break-even point. The break-even point is the point

at which income from sales equals the total cost of producing/purchasing and selling products. When a

company breaks even, its revenue equals its expenses. In other words, at the break- even point, its profit is

equal to zero. For a company to make any money at all, its sales must be greater than the break-even point.

To calculate the break-even point, you must first know:

n    The fixed expenses for making the product

n    The variable expenses for making or purchasing each unit of the product

n    The expected selling price of each unit of the product

The fixed expenses are costs that a business incurs, such as rent and insurance, that do not change based

on the number of units produced or purchased from suppliers. These costs remain the same regardless

of how much a company produces. It’s sort of like your car payment: No matter how much you drive your

car—one mile or 10,000 miles—your car payment is the same every month.

A variable expense changes based on the number of units produced or purchased from suppliers. Exam-

ples of variable expenses include labor and materials. The more units produced or purchased, the higher

the variable cost. Think of your car as an example again. The gasoline you put in your car is a variable

expense. The more you drive your car, the more gas you use—resulting in a higher variable cost.

The basic formula used to calculate the break-even point is:

Revenue – Variable Costs – Fixed Costs = $0

In this formula, the zero represents the break-point—the point at which revenue or sales is equal to

expenses.

Chapter 24

Student Guide