Breakeven Analysis

For a firm, the breakeven point is the quantity of the sales required by the firm to cover its total cost, i.e., Total revenue = Total cost. At this quantity of sales the firm's net income is zero.

We know that:


F includes both fixed operating cost and fixed financing cost.

Breakeven quantity is the quantity where EBIT = 0. So, we solve for Q where EBIT = 0.

Q=(Total Fixed Cost)(PVC)Q=\frac{(\text{Total Fixed Cost})}{(P-VC)}


Let's say we have the following data about a company:

Price per unit = $8

Variable costs = $6

Fixed operating costs = $20,000

Fixed financing costs = $60,000

The breakeven quantity will be calculated as follows:

Q=80,00086=40,000 UnitsQ = \frac{80,000}{8-6} = \text{40,000 Units}

The following graph summarizes the relationship between sales, costs, net income and net losses.

We can make the following observations from the above graph:

  • A firm with higher operating and financial leverage will have higher breakeven quantity.

  • Leverage magnifies the impact of change in sales on change in net income.

We can also modify the above formula to calculate the operating breakeven quantity:

Q=(Fixed Operating Cost)(PVC)Q=\frac{(\text{Fixed Operating Cost})}{(P-VC)}

In the above example, the operating breakeven quantity will be:

Q=20,000(86)=10,000 unitsQ = \frac{20,000}{(8 - 6)} = \text{10,000 units}

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