What is Break Even?
Break-even analysis helps businesses choose pricing strategies and manage costs and operations. A company’s breakeven point is the point at which its sales exactly cover its expenses. The incremental revenue beyond the break-even point (BEP) contributes toward the accumulation of more profits for the company.
The breakeven point tells owners how much they need to sell to cover all their costs and reach profitability. It may help owners decide whether to raise prices, cut costs, expand, or seek a loan or new investors. At the breakeven point, a business is operating at neither a loss nor a profit. Beyond this point, more sales mean it starts to generate a profit. Below that, it’s operating at a loss.
Limitations of Break-Even
There are certain limitations to Break-even analysis such as:
- Its assumes that the fixed and variable costs remain constant over time but practically costs may change due to inflation and changes in market conditions,
- It also assumes all output is sold, which is often not the case,
- The break-even calculations are based on the assumption that the change in a company’s variable costs is related to the change in revenues which is not always true, and
- The break-even analysis does not consider cash flow.
How to Calculate Break-Even
You simply need the total costs to match the total revenues to get your break-even point.
TOTAL COST = TOTAL REVENUES
Break-Even Point (BEP) = Fixed Costs ÷ Contribution Margin
The contribution margin is the selling price per unit minus the variable costs per unit.
The steps to calculate the break-even point are as follows:
- Calculate Fixed Costs (Fixed costs are expenses that typically stay the same each month)
- Calculate Contribution Margin
- Divide Fixed Costs by Contribution Margin
Please review my blog: https://accountingblogger.com/internal-rate-of-return-irr/
The breakeven point can be calculated either
- total dollar sales or
- total product unit sales required for the business to breakeven.
Break Even Point in Units
Unit break-even analysis calculates the number of units that need to be sold to break even.
Now we know that the formula for break-even in units is as follows:
Break-Even Quantity = Fixed Costs / (Sales Price per Unit – Variable Cost Per Unit)
where:
- Fixed Costs (Fixed salary, rent, insurance etc;)
- Sales Price per Unit is the selling price per unit
- Variable Cost per Unit is the variable cost incurred to create a unit
Example 1
ATIF Corporation has calculated its fixed costs at $50,000 which includes lease, insurance, salaries, and others. Their variable costs which include raw material, labour, and sales commissions is calculated as $1.50 per unit. The selling price is $3.00 each.
Break-Even Quantity = Fixed Costs / (Sales Price per Unit – Variable Cost Per Unit)
=$50,000 / ($3.00 – $ 1.50)
=33,333 units
Which means you need to sell 33,333 units to cover your fixed costs.
Break-Even Point in Sales Dollars
Sales break-even analysis calculates the sales revenue that needs to be generated to break even.
Breakeven point (sales) = (total fixed cost × selling price per unit)/contribution per unit.
We can also use below formula:
Revenue required = Fixed Costs / 1 – (Variable Costs / Selling Price)
We will use same example 1 above with same data to calculate Break-Even Point in Sales Dollars as:
= $50,000/1-(1.5/3.00)
=$100,000
To break even, company would have to generate $100,000 in revenue.
Factors that affect breakeven point
- Price of product or service
- Volume of sales
- Changes in fixed or variable costs
Calculate Break-Even by Calculator
https://www.calcxml.com/calculators/breakeven-analysis
https://www.experian.co.uk/blogs/latest-thinking/small-business/break-even-calculator/
The Bottom Line
The breakeven point is one of the most important concepts in business and is an important data point that helps inform many business decisions. It is also an important management metric for startups and established businesses alike, especially for making strategic decisions.
The biggest drawback is that most companies do not disclose enough data to the public to calculate the Breakeven Point accurately. Further, the break-even analysis does not consider cash flow, inflation factor and market conditions.
With the break-even point, you can strategically plan and forecast the financial health of your business or new ventures. A lower break-even point means that your company must sell fewer units or products to break even. A higher break-even point means your business must sell more units or products to break even. Investors should always consider calculating a potential investment’s break-even point before committing to any project.
ABOUT THE AUTHOR
Humayun Atif | CMA, CPA, CA (FIN), MS-IT, CA Articles from Big 4, Certified Forensic Accountant (USA), Six Sigma & Oracle Certified.
Atif is passionate about Business, Tech, and the written word. He is the author of the book ‘IFRS Made Easy’. He is a Tax and IFRS coach and the founder of accountingblogger.com
Great insight 👍