Break-Even Point: Definition, Example, and How to Calculate
What is the Break-Even Point?
The amount of sales at which net income is equal to zero and total revenues are equal to total expenses is known as the break-even point. This is often referred to as the no-profit, no-loss point. The executives of the organization have found this concept to be quite valuable in a number of different areas, including profit forecasting and planning, as well as analyzing the impact of various business management choices.
There are two approaches that may be used to determine a company's break-even point, often known as the BEP. It may be calculated in terms of physical units, such as production volume, or it can be calculated in terms of monetary value, such as sales value.
Break-even points may be used in several scenarios. The break-even point in real estate, for instance, refers to the moment at which the homeowner's net earnings from selling the property equals the net purchase price of the property. This would include any and all expenses associated with the closure of the deal, as well as any and all costs associated with taxes, fees, insurance, and interest paid on the mortgage. This would also include any and all costs associated with maintenance and home renovations. At such a price, the homeowner would perfectly break even, i.e., neither make nor lose any money due to the sale.
BEPs are also used for trading by traders. This involves determining what price security has to achieve in order to precisely pay all expenses connected with trade, such as taxation, commissions, management costs, and so on.
Break-Even Point Components
1. Fixed Cost
The term "fixed costs" refers to expenditures that remain the same regardless of whether the number of units sold or produced varies. This is due to the fact that they are not directly involved in the process of making a product or providing a service. As a direct result of this, fixed costs are seen as indirect costs.
Some examples of fixed costs are property taxes, rent, salary, and the cost of benefits for employees who are not sales-related or management-level.
Some organizations have very high fixed costs, such as manufacturing companies that must pay for equipment and office space, even if they haven't made a single sale.
On the other hand, several organizations have very low fixed expenses but very high variable costs. For instance, a mobile dog groomer may have little fixed cost but extremely high variable costs (such as shampoo, dog treats, mileage, and other accessories).
2. Variable Cost
A variable cost is a kind of operating cost that shifts in proportion to changes in activity level or output. In general, variable expenses grow or decrease according to output amount. Fixed costs are the opposite of variable costs since they do not vary no matter how much or how little something is produced. Variable costs are thus more responsive to changes in output.
Direct labor, the cost of electricity, and the cost of raw materials are all examples of variable costs. All of these are together referred to as COGS, or cost of goods sold. Because variable costs can often be altered in a much more straightforward manner than can fixed costs, it is of the utmost importance for those in charge of running an organization to pay close attention to the movement of variable costs on a consistent basis.
Fixed vs. Variable cost
An owner of a firm may learn how to detect economies of scale by first being familiar with the differentiation between fixed and variable costs. Economies of scale take place when a company reduces its operating expenses and increases the number of goods it produces. By attaining economies of scale, a corporation is able to distribute fixed costs across a greater number of goods or services while simultaneously reducing variable costs, which leads to considerable cost savings for the company as a whole.
The capacity of a business owner to gain an accurate image of the cost structure of the company is greatly impacted by both fixed and variable costs; thus, it is essential to have a good understanding of the differences between these two categories of expenses.
How to Calculate the Break-Even Point
When it comes to calculating the break-even point, there are two basic formulas that are often utilized. The first formula is the break-even point in terms of units, while the second one is the break-even point in terms of sales. For each of these approaches, you will need to be aware of your fixed costs, variable costs, and cost of sales.
Break-Even Point in Terms of Units
Break-Even Point (Units) = Fixed Costs ÷ (sales price per Unit - Variable Cost per Unit).
Fixed costs are expenditures that remain constant regardless of the number of units sold. The sales price is the price of the product that is being sold, and variable costs are costs associated with labor, materials, and other expense.
Break-Even Point in Terms of Sales
Break-even point = Fixed Costs ÷ Contribution Margin
In order to get the sales break-even point, fixed costs must be divided by the contribution margin.
The contribution margin is defined as the difference between the revenue and total variable costs. For instance, if the price of a product is one hundred dollars, the total variable costs are sixty dollars per product, and the fixed costs are twenty-five dollars per product, then the contribution margin of the product is forty dollars ($ 100 - $ 60). The 40 dollars shown here are the money that was taken in to pay the fixed cost. It is important to note that fixed costs are not taken into account when calculating the contribution margin.
Q. Ethan has just launched his own baking business. According to his calculations, his fixed expenditures/fixed costs for the first quarter will amount to $16,000. These costs include the rent for the store. His final variable costs come out to be $8.88 for each cake that he bakes. Ethan sets the selling price of his cakes at around $20 since he wants to earn a nice profit and because his cakes are wonderful. How many cakes will need to be sold in order for Ethan to make up for his initial investment? And how much money will he need to earn in order to meet his financial obligations?
=>>Let's begin by taking a look at the number of cakes that Ethan needs to sell:
The break-even point is expressed in units and is calculated as follows: fixed costs/ (Sales Price per Unit - Variable Costs per Unit)
Break-Even Point in Units = $16,000 / ($20 - $8.88)
Break-Even Point in Units = $16,000 / $11.12
Break-Even Point in Units = 1,439 (Approx.)
To put it another way, for Ethan's business to reach its break-even point, he has to sell around 1,439 cakes.
Okay, how much money does it equal?
The next step of the formula is as follows.
Break-Even Point in $ = Sales Price Per Unit x Break-Even Point in Units
Break-Even Point in $ = $20 x 1,439
Break-Even Point in $ = $28,780
In order for Ethan to reach a point where he is no longer losing money, he is going to have to bake a lot of cakes, i.e., 1439
Benefits and Drawbacks of the Break-Even Point
1. Making Decisions Regarding Budgets and Objectives
Budgets for different company activities may be planned with more precision when a break-even point analysis is performed. In addition, they are able to establish goals to increase the production pace and successfully accomplish these goals to generate a beneficial result.
2. Managing Expenses
Both fixed and variable costs have the potential to influence the profit margin of a business. However, by doing a break-even analysis of the company operations, they will be able to determine whether or not there are any impacts that are altering the value of the costs. In these kinds of circumstances, exercising proper cost management becomes an absolute must in order to guarantee that they will make a profit from their commercial activities.
3. The Formulation of a Pricing Strategy
When calculating break-even points, the pricing of items has a significant influence on the outcome. For example, if product prices were to rise, a reduction in the break-even point would be expected. For instance, if a company is previously required to sell 50 units of this product to achieve break-even, increasing the price will reduce that number to 45.
4. Modifying the Existing Business Model
A break-even analysis has to be carried out prior to the company making any significant changes to its business model, such as transitioning from the wholesale industry to the retail sector. The break-even analysis will be helpful in determining the price to sell at since the costs are subject to significant variation.
1. Does Not Foresee Demand
Even if a break-even point analysis may tell you when you will be profitable again, it does not provide any information on the likelihood that this will truly occur. In addition, demand isn't consistent, which means that even if you believe there is a gap in the market, the threshold at which you reach break-even can turn out to be far higher than you had originally estimated.
2. Depends on Valid Data
The accuracy of your data determines how accurate your break-even analysis will be. If your estimates are incorrect or if you have to deal with prices that are constantly shifting, the break-even analysis you have may not be the most helpful tool you have.
3. Ignores Competition
One of the drawbacks of break-even analysis is that it does not take into account the impact of competitors. New competitors may alter consumer demand for your goods or force you to adjust your pricing, which will probably have an impact on your break-even point.
4. Not for Businesses that Manufacture More than One Product
The break-even analysis works most effectively for businesses that have just one pricing point. If you sell a variety of items with different pricing, then a break-even analysis can be too broad for your needs. It is important to keep in mind that costs are highly variable, which means that the point at which you reach financial stability may need to be monitored, evaluated, and readjusted at a later date.
Strategies for Lowering Break-Even Point
Companies, particularly newer ones, seek to maintain their break-even thresholds as low as possible so that they may start making a profit as quickly as possible.
Here are some possible approaches for you to do that:
The point at which a firm's revenues are equal to its expenditures is referred to as the break-even point, and it is a key financial benchmark used by management to guarantee that the company is profitable. It is defined as the moment at which sales and costs are equivalent to one another or as the time when a company's sales are sufficient to pay the expenses of the firm. Although generating a profit is desirable, paying off debt and operating costs comes first for most businesses.
To be able to determine the point at which a firm is profitable again, the owner of the company needs to be familiar with the formula of the break-even point, but before they can do so, they need to have an understanding of the variables/costs involved. There are two types of costs to consider: fixed costs, which do not change regardless of output or sales volume, and variable costs, which do alter as the production or sales increase or decrease. When using the break-even formula, the break-even point in units sold and the break-even point in dollars must be kept separate. Here are the formulas:
With the help of the break-even formula, managers are able to efficiently analyze the fundamental health of a company and make future actions for the expansion of profits and the reduction of expenses.