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Break-even analysis is a part of cost-volume-profit (CVP) analysis. These techniques focus on how selling prices, sales volume, variable costs, fixed costs and the mix of product sold affects profit. It provides understanding the relationships between cost, sales volume and profit which ultimately help you to make better business decisions.

There are four key components of CVP Analysis;

Contribution Margin Ratio Analysis (CM)

Break-Even Point Analysis (BEP)

Target Profit Analysis (TP)

Margin of Safety Analysis (MoS)

Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect a company's operating income and net income. This is the level of sales where the company will not incur a loss, yet not make a profit. In performing this analysis, there are several assumptions made, including:

Sales price per unit is constant.

Variable costs per unit are constant.

Fixed costs are constant e.g. rent, insurance and wages

Everything produced is sold.

Costs are only affected because of activity changes.

If a company sells more than one product, they are sold in the same mix.

CVP analysis requires that all the company's costs, including manufacturing, selling, and administrative costs, be identified as variable or fixed.

To be able to explain appropriately, I will break each element into small pieces and explain how to calculate them to effectively establish this analysis. I will use a fiction company and some random numbers throughout the article to be able to explain how we calculate and analyse them accordingly.

**Sample details: Company A sold 500,000 of their products with variable cost per unit of £2.1, fixed cost is £1,700,000 and Sales price per unit of £5.5.**

Note: You can download related excel spreadsheet __here__.

**Revenue, Costs (Fixed and Variable) and Operating Profit**

First, let’s calculate total revenue, costs and operating profit numbers;

**1. Contribution Margin Analysis (CM)**

Key calculations when using CVP analysis are the contribution margin and the contribution margin ratio. The contribution margin represents the amount of income or profits the company made before deducting its fixed costs or in another way, CM is the amount remaining from sales revenue after variable costs have been deducted.

In summary, it is the amount of sales revenue available to cover (or contribute to) fixed costs up until the break-even point is reached. When calculated as a ratio, it is the percent of sales revenue available to cover fixed costs. Once fixed costs are covered, any revenue left contributes to the company’s operations profit.

Contribution Margin = Price per unit – Variable cost per unit

Contribution Margin Ratio = Contribution Margin / Sales Revenue