Break Even Point is a term for business calculations in determining the number of sales to achieve value in return on capital. For more information about this break even point, you can read the article below. You can also read the article Descending Triangle Bullish: Characteristics, Types, Examples, and How to Read.

Definition of Break Even Point

Break-Even analysis refers to the method adopted by a company to determine what level of production and sales should be maintained to ensure that it does not lose money. It is a financial tool, used for economics, business, bookkeeping and accounting. A break-even analysis is the study of the relationship between variable costs, fixed costs, and profits. In other words, the minimum amount in which total costs (fixed and variable) will be covered is referred to as break-even. Once you break even, you don't lose or make money. Only all your expenses are covered. Beyond this point, any sale will be a profit.

How Break Even Point Works

Break even point analysis is a financial calculation used to determine a company's BEP. It is an internal management tool, not a calculation, that is usually shared with outside parties such as investors or regulators. However, financial institutions may ask for it as part of your financial projections on a bank loan application. The formula takes into account fixed costs and variable costs relative to unit prices and profits. A fixed cost is a fixed cost that is the same no matter how many products or services are sold. Examples of fixed costs include renting a facility or mortgage, equipment costs, salaries, interest paid on capital, property taxes and insurance premiums. Variable costs go up and down according to changes in sales. Examples of variable costs include direct labor salary costs per hour, sales commissions and fees for raw materials, utilities and shipping. Variable cost is the sum of the labor and material costs required to manufacture one unit of your product. Total variable costs are calculated by multiplying the cost of producing one unit by the number of units you produce. For example, if it costs $10 to produce one unit and you make 30 units, then the total variable cost is 10 x 30 = $300. The contribution margin is the difference (more than zero) between the selling price of the product and the total cost of its variables. For example, if a suitcase sells for $125 and the variable cost is $15, then the contribution margin is $110. This margin contributes to offsetting fixed costs. Unit Contribution Margin = Selling Price – Variable Cost The average variable cost is calculated as your total variable cost divided by the number of units produced. In general, lower fixed costs result in lower break even points—but only if variable costs are not higher than sales revenue.

Benefits of Break Even Point

Here are some of the benefits of doing a break even point analysis. Break even point analysis is a very useful tool for businesses and has several significant benefits:
  • Business Funding: If you want to take out a loan to fund your business or its expansion, you need to prove that the business idea is profitable. So the break even point will be a key component of your presentation.
  • Cost control: Break even point analysis can be used to detect some hidden jumps or cost drops that may occur, if not go unnoticed. To find out the break even point, accounting firms consider every financial commitment. Furthermore, since you need to consider all the costs, you will include even fixed assets that may be low-cost or whose costs are unknown.
  • Smarter pricing: Break even point analysis will help you price your products better. You will be able to better predict how the selling price will change, will change your profits.
  • Production Planning: You will be able to calculate the optimal production rate so that you can achieve maximum profits without raising prices.
  • Make or buy decisions: If you're considering the option of setting up a supporting product line that helped you during previous product creation. Or whether to buy this product from outside. This will help you determine the most appropriate course of action for that purpose.
  • Efficient Use: Any asset that is more expensive and adds significantly to the cost of your business, without adding value to the product. You will be forced to reconsider its place in your business. This will help you determine the unused capacity of the asset and indicate the maximum profit that can be generated from its use.
  • Product-wise Contribution: You can realize the contribution made by each product line. You can consider increasing the capacity of some business operations or closing others. This will have a huge impact on your profitability.
  • Setting Realistic Targets: You will have an estimated duration of how long it will take before your start-up reaches profitability. How much total sales are needed to reach the break even point etc are calculated and provide concrete goals to work on.
  • Solid Business Planning: Calculating Break Even Points is easy and fast. Decisions made through this are real and fact-based, not conjectural.
  • Solid Business Planning: Calculating Break Even Points is easy and fast. Decisions made through this are real and fact-based, not conjectural.
  • Conditions of uncertainty: Break even point analysis helps financial management by providing information that is deducted by using factual methods.
  • Maintain the risk: you will know if or when to avoid implementing something new. This helps you avoid the risk of failure and/or limit its impact on your business.

Formula for Calculating Break Even Points

The formula for calculating break even points involves taking the total fixed cost and dividing the amount by the contribution margin per unit. To take a step back, the contribution margin is the selling price per unit minus the variable cost per unit, and this metric represents the amount of revenue remaining after meeting all associated variable costs accumulated to generate that revenue. That said, when a company's contribution margin (in dollars) is equal to its fixed costs, the company is at its break even point. If the contribution margin exceeds the fixed cost, then the company actually starts to profit from the sale of its products/services.

BEP Formula

  • Break-Even Point = Fixed Cost / Contribution Margin ($)

Example of BEP Calculation

For example, if a company has $10,000 in fixed costs per month, and their products have an average selling price (ASP) of $100, and variable costs are $20 for each product, that results in a contribution margin per unit of $80. Then, by dividing $10k in fixed costs by a $80 contribution margin, you'll get 125 units as break even points. This means that if the company sells 125 units of its products, it will make a net profit of $0. Alternatively, if using Excel, break even points can be calculated using the "Target Search" function. After entering the final result settled for (i.e., net profit zero), the tool determines the value of the variable (i.e., the number of units to sell) that makes the equation true.

Purpose of Calculating Break Even Points

Basically, a business will want to use break even point analysis whenever considering additional costs. These additional costs can come from starting a business, merger or acquisition, adding or removing products from the product mix, or adding locations or employees. In other words, you should use break even point analysis to determine the risk and value of any business investment, especially when any of these three events occur:

1. Expanding business

A break even point (BEP) will help business owners/CFOs get a reality check on how long it takes for an investment to become profitable. For example, calculate or model the minimum sales required to cover the cost of a new location or enter a new market.

2. Lower prices

Sometimes businesses need to lower their pricing strategy to beat competitors in a particular market segment or product. So, when lowering prices, businesses need to figure out how many more units they have to sell to offset or cover the price drop.

3. Narrowing down business scenarios

When making changes to a business, there are a variety of scenarios and what-if on the table that complicate the decision on which scenario to follow. BEP will help business leaders reduce decision-making to a series of yes or no questions. After knowing about the Break Even Point, then you can later calculate and determine the value of the break even point itself. In addition, you can register for GIC and trade with capital starting from IDR 150,000!