Breakeven Analysis

Breakeven (BE) analysis is a management decision-making tool, useful particularly when fixed costs are a significant portion of an organization's cost structure. Sometimes referred to as cost–volume–profit analysis, BE analysis calculates the level of sales (in units or in dollars) such that an organization earns zero profit on a specific product or project. If the level of sales exceeds the breakeven level, the organization makes a profit; sales lower than breakeven generate a loss.

When referring to units in the BE calculation, the unit must first be clearly defined, because it can be stated with a variety of terms. In a general sense, organizations are[Page 50] interested in measuring the number of physical units produced, or the productivity of human or machine, which would encompass service applications. On a macro level, health organizations may be interested in measuring number of cases, or patient days, or unique visits to a facility. Measuring activity on the micro level may refer to the number of procedures or lab tests. Regardless of the measure, the units being measured must be consistent; the analysis is applied to only one measure of output at a time (for example, a lab makes one breakeven calculation for a blood test and another completely different calculation for a skin fungus test, because the costs involved with each test are likely very different).

BE requires an understanding of fixed costs and variable costs within an organization. Total cost represents the sum of fixed and variable costs. BE is the amount of sales, stated in units or in dollars, that equals total cost; at this level of sales, earnings before interest and taxes (EBIT) equal zero. (See Figure 1.)

Figure 1

The breakeven point is defined as follows:

• BE in quantity terms: Fixed costs/contribution margin in dollars
• Breakeven in dollar terms: Fixed costs/contribution margin ratio
• Contribution margin: Unit selling price – unit variable cost
• Contribution margin ratio: Contribution margin/unit selling price

Original Example Data: The Physical Therapy Clinic (PTC) has fixed costs of $200,000 per year. The average variable cost per patient for providing service is $30 per appointment. The average charge to a patient for each appointment is $50, generating a contribution margin per appointment of $20. The contribution margin ration is $20/$50 = 0.40. To reach a breakeven point and exactly cover fixed costs, the clinic must generate 10,000 patient appointments for the year:

BE in units: $200,000/$20 =10,000 patients

BE in dollars: $200,000/.40 = $500,000

To reconcile using totals,

Appointments beyond 10,000 will generate a positive EBIT:

Assume 15,000 patients, which is 5,000 patients above BE: