Cost-volume relationships

A person starting a new business often asks, “At what level of sales will my company make a profit?” Established companies that have suffered through some rough years might have a similar question. Others ask, “At what point will I be able to draw a fair salary from my company?” Our discussion of break-even point and break-even analysis will provide a thought process that may help to answer those questions and to provide some insight as to how profits change as sales increase or decrease.

Frankly, predicting a precise amount of sales or profits is nearly impossible due to a company’s many products (with varying degrees of profitability), the company’s many customers (with varying demands for service), and the interaction between price, promotion and the number of units sold. These and other factors will complicate the break-even analysis.

In spite of these real-world complexities, we will present a simple model or technique referred to by several names: break-even point, break-even analysis, break-even formula, break-even point formula, break-even model, cost-volume-profit (CVP) analysis, or expense-volume-profit (EVP) analysis. The latter two names are appealing because the break-even technique can be adapted to determine the sales needed to attain a specified amount of profits. However, we will use the terms break-even point and break-even analysis.

To assist with our explanations, we will use a fictional company Oil Change Co. (a company that provides oil changes for automobiles). The amounts and assumptions used in Oil Change Co. are also fictional.