Breakeven Analysis

It will frequently turn out that the crucial variable for a project is sales volume. If we are thinking of a new product or entering a new market, for example, the hardest thing to forecast accurately is how much we can sell. For this reason, sales volume is usually analyzed more closely than other variables.

Break-even analysis is a popular and commonly used tool for analyzing the relationship between sales volume and profitability. There are a variety of different break-even measures, and we have already seen several types. For example, we discussed (in Chapter 9) how the payback period can be interpreted as the length of time until a project breaks even, ignoring time value.

All break-even measures have a similar goal. Loosely speaking, we will always be asking: "How bad do sales have to get before we actually begin to lose money?" Implicitly, we will also be asking: "Is it likely that things will get that bad?" To get started on this subject, we first discuss fixed and variable costs.

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