What Is Break-Even Point?
The break even point is the level of output at which the company’s overall revenue and total expenses are the same. At BEP, the company’s revenues from the sale of manufactured goods are equal to the overall production expenses of the product. In accounting terms, the company’s overall profit is zero at this time. As a result, there is no profit and no loss for the business.
The business “breaks even.” Any corporation that wishes to make an abnormal profit demands a break even point.
Financial Break-Even Point enables you to evaluate the extent to which your product or service sales equal your costs. This point at which your sales exceed your operating costs is referred to as your break even point (BEP).
A Break-Even Point can be represented graphically using a break even chart. The break even analysis chart explains the various costs associated with varying levels of sales.
Break-even analysis for new companies is a critical calculation. All new firms want to know when they can anticipate profitability.
How to Calculate Break-Even Point
You can compute your break even point in more than several ways. It can depend on the number of units or sales.
1. Break-even point expressed in terms of units –
Break-Even point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)
In the business world, fixed costs remain constant regardless of the number of units sold. Revenue is the amount of price at which things are sold less variable costs such as materials, labour, etc. To obtain the break even point per unit, you must divide the fixed costs by revenue per unit, deducted by variable costs per unit.
2. Break-even point expressed in terms of Sales –
Break-even point= Fixed Costs ÷ Contribution Margin
Divide fixed costs by contribution margin to obtain break even points based on sales volume. To calculate contribution margin, variable costs are subtracted from the product’s selling price (price).
To make both of the Break-Even Point Formulas easier to understand, the components can be summarized as follows:
i) Fixed costs: These costs include rent (for the store and production), assets such as computers and software, as well as advertising and public relations charges, among other things.
ii) Contribution margin: Subtraction of variable cost from selling price yields contribution margin. The differential is utilized for fixed cost recovery.
iii) Contribution margin ratio: This value is determined by the contribution margin reducing fixed costs. After determining the contribution margin ratio, you can compute your break even cost by reducing expenses or increasing income.
iv) Profits: If your sales are equal to the fixed and variable costs, break even is achieved. Any additional revenue contributes to net profit.
When Is Break Even Point Significant:
When it comes to economic principles, the term “break even point” meaning can be traced back to the term “point of indifference.” The calculation of an enterprise break even point is a simple but analytical tool for organizations. In its simplest form, a break even point analysis provides insight into whether or not a product’s or service’s revenue can cover its manufacturing costs. Furthermore, the break even point is beneficial to managers since the information presented can make critical decisions in the corporate world.
If the break even point is higher than the projected demand, resulting in a loss on the product, the manager might use this information to make decisions regarding the product. He may decide to cancel the product, boost advertising, or re-price it to increase demand. Thus, the break even chart displays the cost-income and volume relationships in a straightforward but effective manner that even a layperson can understand.
- The break even chart assists managers in determining the level of sales required to break even. The break even chart is especially significant because it enables management to quickly visualize the impact of a change in selling, fixed expenses, and variable costs on profitability. Another critical application of the financial break even point is to assist in determining the relative importance of fixed and variable costs. With more flexible labour and equipment, the fixed price is reduced, lowering the break even point. The relevance of the break even point in business and decision-making cannot be emphasized.
- Break-even analysis is the most effective and crucial managerial method for analyzing cost-output-profit relationships at various output levels. This allows the top management to develop their operational strategy. Additionally, a finance manager can utilize this technique to forecast profitability at varying production and sales levels.
- The analysis provides valuable insight into the company’s operational risk. A finance manager can measure the degree of profit stability by comparing fluctuations in expected future volume to the estimated break even point. This allows financial management to determine the company’s ability to service debt.
- Break-even analysis is critical for start-ups. It assists them in determining the profitability of a business concept and in developing pricing strategies and prices.
- Break-even analysis is also a critically important area of focus for firms when they introduce a new product or service to the marketplace, mainly if producing or operating the good or service involves significant expenditures.
- Costs might vary significantly when a business changes its strategy, depending on whether it is downsizing or scaling up. Thus, break even analysis is critical for firms when altering their business models and determining selling prices.
Break-Even Analysis Examples:
Suppose you want to start a new business offering smartphone applications. Assume the following facts regarding your costs and revenues:
The average selling price that should be expected is $5.
Fixed costs are estimated to be $75,000. (This amount is sufficient to cover your wage and the price of a small office.)
These costs will remain constant regardless of the number of apps sold.
Variable costs = $0.25 (This is the transaction fees associated with each sale.)
With this information, we can compute the break even point in the following manner:
BEP = $75,000 / ($5 – $0.25)
Consequently, if you round your sales figures up to the next unit, you’d need to sell 15,790 copies of your app to break even.
Importance of Break Even Analysis For Small Businesses
A break even analysis establishes the point at which a small business may anticipate covering all the costs while still earning a profit. Small business owners can specify the number of sales required for business expenditures regularly by identifying start-up costs. Even after a certain period, break even analysis can help determine the appropriate pricing strategy for new products or services.
Many small business entrepreneurs launch a product or service without fully comprehending the total costs.
- Calculation of costs – A break even analysis can assist you in determining if your organization will remain profitable when your fixed costs increase.
- Budgeting and goal setting – A break even analysis can also assist you in budgeting by providing an estimate of your profitability for the coming month, quarter, or year.
- A tool for motivation – A break even analysis can assist you in determining sales targets and can inspire you to work much more complicated when your profitability is at stake.
- The margin of safety – By analyzing the breakeven point to the predicted profitability, you can readily identify when sales are falling short of becoming profitable and successful.
- Ensure the Accuracy – Ascertaining the reliability of a break even analysis requires a thorough analysis of the expenditures and pricing associated with your organization. You must understand the complete expenses related to delivering your services and products to customers.