Unit 11
Accounting and Finance Foundations Unit 11: Financial Analysis 849
Financial Analysis
We need to go a couple of steps further to determine exactly how many products we would need to sell to
make our sales exactly equal to our expenses, though. First, remember that total revenue is equal to the
total number of products sold times the sales price per product (variable “x”). Also, total variable expenses
are the total number of products produced and sold multiplied by the variable cost per product (variable
“x”). So, our formula becomes:
(Sales Price Per Product * x) – (Variable Costs Per Product * x) – Total Fixed Costs = 0
Then, all we need to do is get the x to one side of the equation. So, the formula for finding the break-even
point (x) reads:
x = Total Fixed Costs / (Sales Price Per Product – Variable Costs Per Product)
Example: Joe, who is opening an ice-cream shop, wants to know how many ice cream cones he must sell
to break even. Joe incurs a monthly rent expense of $500 and a note payment of $300. It costs Joe $0.04
for each cone, $0.12 for a scoop of ice cream, and $0.03 for sprinkles. If Joe sells an ice cream cone for
$1.15, how many must he sell to break even?
Solution: Fixed costs stay the same from period to period. In this example, fixed costs are the rent
expense and the note payment. So, to determine the break-even point, you must first determine the total
fixed costs by adding Joe’s monthly rent expense and note payment together.
Total Fixed Costs = $500 + $300 = $800
Variable costs change based on use, so in our example, the more ice cream cones Joe sells, the more
cones, ice cream, and sprinkles he will have to buy. Therefore, your next step needs to be calculating the
total variable costs per ice cream cone by adding together the cost of one cone, one scoop of ice cream,
and one serving of sprinkles.
Total Variable Costs Per Ice Cream Cone = $0.04 + $0.12 + $0.03 = $0.19
Next, plug the selling price of an ice cream cone (given to you in the example), the total fixed costs, and the
total variable costs per ice cream cone into the formula for break-even point.
x = $800 / ($1.15 – $0.19)
= $800 / $0.96
= 833.33 cones
So, to break even, Joe must sell 834 ice cream cones (since he can’t really sell exactly 833.33 cones).
The contribution margin is a concept related to the break-even point. Even though the selling price per
product or unit less the variable cost per product or unit is often referred to as the profit per unit, it is actu-
ally the contribution margin. Until the break-even point is reached, the profit per unit contributes to paying
the fixed costs—thus the term contribution margin. Essentially, until a company reaches its break-even
point, all of the revenue coming from sales is being used to pay fixed expenses.
Chapter 24
Student Guide
Lesson 24.1 Break-Even Analysis (cont’d)