Total variable costs of production are indicated by the broken line sloping upward, which illustrates that total variable costs increase directly as production increases. Total fixed costs do not change as the level of production increases. Total fixed costs are shown in Figure 1 by the broken horizontal line. Average variable costs are the variable costs per unit of output or of TVC divided by units of output. Total variable costs (TVC) are the sum of the variable costs for the specified level of production or output. They may include cost of goods sold or production expenses such as labor and power costs, feed, fuel, veterinary, irrigation and other expenses directly related to the production of a commodity or investment in a capital asset. Variable costs change in direct relation to volume of output. Total fixed costs are the sum of the fixed costs. Fixed costs include, but are not limited to, depreciation on equipment, interest costs, taxes and general overhead expenses. To explain how break-even analysis works, it is necessary to define the cost items.įixed costs, incurred after the decision to enter into a business activity is made, are not directly related to the level of production. Break-even analysis computes the volume of production at a given price necessary to cover all costs.īreak-even price analysis computes the price necessary at a given level of production to cover all costs.

A break-even point defines when an investment will generate a positive return and can be determined graphically or with simple mathematics.

Total fixed costs do not change as the level of production increases.īreak-even analysis is a useful tool to study the relationship between fixed costs, variable costs and returns.

Variable costs change in direct relation to volume of output.

Fixed costs are not directly related to the level of production.

A break-even point defines when an investment will generate a positive return.

If such an ad campaign raised your unit sales from 6,000 to more than 7,000, it would be considered successful.By P.H. Raising your advertising budget by $5,000 per year would raise your fixed costs to $35,000 and your breakeven point to 7,000. This calculation can be used when considering the benefits of advertising.

Increasing sales: Assuming breakeven unit sales of 6,000, increasing the number of units sold to 10,000 would boost profits by $20,000 (4,000 units at $5 per unit).

For example, a builder could source lumber from a lower-cost supplier or take advantage of equipment and/or technology to automate production. Variable costs typically are lowered by reducing material or labor costs.

Reducing variable costs: Reducing variable costs by $1 also would lower the breakeven point by 5,000 units.

Reducing rent and payroll are common ways for businesses to reduce fixed costs, as is relocating to other jurisdictions that have lower business taxes or utility costs. Reducing your fixed costs: If you were able to reduce your fixed costs by $5,000, you also would reduce the breakeven point to 5,000 units sold.However, increasing the selling price often is not an option in a highly competitive environment.

Increasing the selling price: Staying with the example of $12 widgets, increasing the selling price by $1 reduces the number of units you need to sell by 1,000 based on a new calculation: $30,000/($13-$7)=5,000.

Break even analysis