What is Break-Even Analysis and Cost Volume Profit Analysis?

Let’s say you’re an advertising executive and after you create your new ad, your cola sales jump to $1 million. That is something good? Yes?

Actually, you don’t know! Why? What if you spent $1 million on advertising costs and the ingredients and packaging for your cola also cost $1 million, for a total of $2 million? You will have earned $1 million dollars, but you will have spent $2 million dollars on advertising plus “cost of goods”. In addition, you will still need to add business expenses such as rent, salaries, etc.

So how much should your advertising increase in sales before we can say that the additional sales you got from advertising are enough to at least pay for all of your costs and expenses? Maybe $2 million? $3 million? How much exactly?

This is the concept of “Break Even”. A business break-even point is the exact amount of sales you need where the money will be enough to pay your costs and expenses. On the other hand, the breakeven point of a project (for example, an advertisement) is where the increase in sales generated by the new project is enough to pay for the additional costs and expenses generated by that new project. Keep in mind that breaking even doesn’t mean you’re making a profit yet either; As I said before, it just means that you are earning enough to pay your costs and expenses.

So, to make a profit, you would need to 1) sell more so you could break even and/or 2) increase the “contribution margin” on your product. What is the contribution margin? It is the difference between the price at which you sell your product and your “variable costs”. Variable costs are costs that are not “fixed” (fixed costs are things like fixed rents and fixed salaries that may not increase even as you produce and/or sell more products/services). Therefore, contribution margin is different from “profit” because when we calculate profit, we include fixed costs and overhead.

Cost, volume, and profit analysis, on the other hand, is very similar to but broader than break-even analysis, as it includes going beyond just calculating how much to sell to cover costs and expenses. With cost-volume-profit analysis, we also try to figure out how much we should sell if we want to achieve a certain target profit, and we also take taxes into account.