Considered a margin of safety measure, break-even analysis measures the volume a business must reach to recover its total expense outlay. Understanding break-even analysis is particularly important for small businesses whose margins are easily impacted by rapid adjustments in the marketplace, and when necessary need to make course corrections. Once a business has crossed its break-even threshold, all fixed costs have been paid for the period while all variable costs have been paid up until that point leading to each additional sale effectively becoming pure profit.
Although a break-even analysis can be used by management to determine levels of production or desired sales mix, this particular break-even analysis tool measures a companies level of fixed cost relative to profit earned by each additional unit produced and sold that contributes to revenue. Theoretically, a company with no fixed costs will break even on its first sale, assuming variable costs do not exceed revenue.
The input data is found in the business's Income Statement. The period timeframes can be measured in years or quarters, and the results are based on Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA). It is not necessary to include those metrics in the calculation. Also, it is helpful to look for trends in the results, and the tool can also be used to project break-even.