A firm’s break-even point is the point at which it generates enough revenue to cover its costs. Break-even analysis is an attempt to find out what level of sales volume the firm has to achieve at a specific price to break even. Break-even analysis also helps with pricing decisions. Anything a firm sells beyond the break-even point adds to its revenue. Changes in costs and price have effects on the break-even point.
Changes in Fixed Costs
Some of the firm’s production costs are fixed. The firm’s fixed costs, such as rent, are not directly dependent on the level of output. If a firm’s fixed costs go down, its break-even point goes down too as it needs to sell fewer units to recoup its fixed costs. And as the fixed costs go up, its break-even point goes up as it needs to sell more units to recoup the costs.
Changes in Variable Costs
A firm also has some production costs that are variable. For instance, its labor costs rise if there is a significant change in output. Changes in variable costs also have an effect on the break-even point. If the company's variable costs go up, it will need to sell additional units to recoup its costs and break even. And if the variable costs go down, it will break even at a lower level of sales volume.
Changes in Price
Changes in sales price also impact a firm’s break-even point. When a firm’s sales price goes up, it generates more revenue, if demand for the product remains constant. This means that it could break even at a lower sales volume. And if the firm’s sales price goes down, it generates a lower level of revenue from sales if demand does not change. This means that it needs to sell more units to break even.
Uses of Break-Even Point Analysis
Managers use break-even point analysis to determine whether they are breaking even and meeting their costs. This helps them determine whether to continue in business or not. This sort of analysis also helps in making decisions such as whether to cut prices. If a firm cuts its prices, it has an impact on demand. If the firm finds that it is making a bigger profits with the lower price, as demand rises, even though its break-even point has gone up, it could decide to go ahead and lower prices.