What is breakeven point?

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Break even point

In any business model it is very important to know when you start making profits and when you start to incur losses. This is necessary as it assists the investor in making decisions about fixing an optimum price for his product or services. If the price is competitive then the profit made in the business is healthy and sustainable over a longer period of time. An analysis that is helpful in determining the aforementioned indices is the breakeven point.

The breakeven point is the point at which the total revenue of a business is matching the total cost incurred by the business without the business making a profit or a loss. At this point the sales made by any firm exactly matches it expenses. It is fundamental in business, cost accounting and economics. It is used to monitor the viability of a business by knowing when to increase price or when to reduce production if the market is not responding well to the goods or services in question. At this point there is no net loss or gain. Both of them are equal.

The breakeven point is based on an assumption that a variation in the costs incurred by a firm is linked to change in its revenues. Some scenarios within the same business model do not support this assumption.

They are:

  • The firm could have different product, that have fluctuating levels of profitability
  • The firm could have different type of customers who seek for unequal amounts of attention. This may lead to unanticipated increase in cost.
  • The firm can be selling its product in different markets
  • The sales mix of the company may regularly fluctuate.

The breakeven point is not a generic value that is common across board. Each business has its own unique breakeven point. It is up to the owner of the business to look for ways of calculating his breakeven point taking into consideration the various costs that he incurs while setting up and running the business. Breakeven point calculations are mainly done to decipher the minimal output that must be exceeded before a business can be said to be making profit. It gives a raw insight into how marketing activity impacts on earnings.

Breakeven point is a very simple analytical tool that can be used to monitor the dynamic relationships that exist between sales, costs and profits in a business. The concept of target income sales is an exotic brand of breakeven point. This is because target income sale is that particular at which the business starts to make profitable income. A good use of breakeven point analysis helps a business owner to know when to increase or reduce marginal costs. It helps the accountant predict level of expenses that could be injurious to the business in the long run. This ensures that the business is run effectively and efficiently. A new entrant into any business should be able to calculate his breakeven point as it would arm him with enough knowledge about the challenges he may face while trying to make profit. It will also let anybody who wants to invest in the business know the quality and quantity of profit to be expected from the business.

How to calculate the breakeven point?

To effectively compute the breakeven point of a firm in sales volume, three indices must be determined.

They are:

  • The fixed cost (FC). This is the type of cost that does not directly affect the sales. They include land, rent, telephone bills, power bills and wages.
  • The variable cost (VC). This is the cost that is directly linked to the sales of the product. It includes marketing, raw materials, cost of manufacture etc.
  • Sale price/selling price (SP). This is the price at which the good is sold to the end user. This is the price which the company feels will give it a competitive edge in the market.

Mathematically, breakeven point can be calculated in units using the formulae:

  • FC÷(SP-VC)= BREAKEVEN POINT
  • Where FC is the fixed cost, VC is the variable cost and SP is the selling price.
  • SP-VC= Contribution margin.

So breakeven point from a theoretical point of view is when the fixed cost is divided by the difference between the selling price and the variable cost. The difference between the selling price and the variable cost is the denominator of the equation and is also known as the contribution margin (CM). Thus the equation can be rewritten as;

  • FC÷CM, where FC is fixed cost and CM is contribution margin.

To calculate for breakeven point in dollars the following formulae is useful;

  • SP×BP in units=BP in dollars, where SP is the selling price. BP is Breakeven Point.

This means that to compute the dollar amount of the breakeven point one can simply multiply the price(SP) by the breakeven point in units (BP in units).this particular calculation assist in enabling the businessman know the dollar amount in sales that will be achieved before he gets zero profit and zero loss.

Also breakeven analysis can be calculated by using the formulae:

  • (Desired or anticipated profit in dollars ÷ contribution margin) + breakeven point in units

To enable us understand fully the calculation and formulae involved in solving for breakeven point, the following example may be helpful.

  • Ken is an accountant in a furniture plant. He is trying to know the amount of tables that will be produced for the company without making a loss. These are the values of the fundamental indices. Total Fixed cost is $600,000, variable cost per unit is $400, selling price per unit is $600.anticipatedor desired profit is $300000.

Formulae for calculating breakeven point per unit is= FC÷ (SP-VC), therefore applying the formulae,

600000÷ (600-400) =600000÷200=3000units is the breakeven point in units. Hence Ken must ensure the company sells 3000units to fully cover for its fixed and variable costs.

To get the dollar equivalent, Ken can multiply the breakeven point in units which is 3000 by the price, which is $600……..3000×$600=$1800000

To get the breakeven analysis. The following steps are taken;

  • (Desired or anticipated profit in dollars ÷ contribution margin) + breakeven point in units

(300000 ÷ 200) +3000

1500+3000 = 4500.

What this means is that 4500 units of furniture will be sold for the firm to reach its projected profit target.

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