The Break-even point (BEP) is a major inflection point in every business and sales organization. Here, we can learn about Break-Even Analysis and how to calculate BEP.
If you’re a Company owner, you should know about Break-even point (BEP) and how to calculate it. It is important for making right business decisions and financial planning.
What is the Break-Even Point(BEP) ?
The BEP refers to the amount of revenue at which a business earns a profit of zero (i.e. total expenses and total revenue balance out). In other hand, the point at which revenue from sales covers all expenses. If you sell less than BEP, then the company will lose money. If you sell more than BEP, then the company’s gross profits will begin to rise. Break-Even Sales amount exactly covers the underlying fixed expenses of a business, plus all of the variable expenses associated with the sales.
It is useful to know the break-even sales level, so that management has a baseline for the minimum amount of sales that must be generated in each reporting period to avoid incurring losses. For example, if a business downturn is expected, the break-even level can be used to reduce fixed expenses to match the expected future sales level.
What is a Break-Even Analysis?
Break even analysis is a business accounting process for determining at what point a company, or a new product or service, will be profitable. It’s a financial calculation used to determine the number of products or services you need to sell to at least cover your production costs. In simple, break-even analysis is very useful for knowing the overall ability of a business to generate a profit.
In the case of a company whose breakeven point is near to the maximum sales level, this signifies that it is nearly impractical for the business to earn a profit even under the best of circumstances. Therefore, it’s the management responsibility to monitor the breakeven point constantly. This monitoring certainly reduces the breakeven point whenever possible
When is Break-even analysis used?
● Starting a new business:
– To start a new business, a break-even analysis is a must. Not only it helps in deciding whether the idea of starting a new business is viable, but it will force the startup to be realistic about the costs, as well as provide a basis for the pricing strategy.
● Creating a new product:
– In the case of an existing business, the company should still perform a break-even analysis before launching a new product—particularly if such a product is going to add a significant expenditure.
● Changing the business model:
– If the company is about to the change the business model, like, switching from wholesale business to retail business, then a break-even analysis must be performed. The costs could change considerably and breakeven analysis will help in setting the selling price.
How Break-even analysis is useful to the company ?
● It helps to determine remaining/unused capacity of the company once the breakeven is reached. This will help to show the maximum profit on a particular product/service that can be generated.
● It helps to determine the impact on profit on changing to automation from manual (a fixed cost replaces a variable cost).
● It helps to determine the change in profits if the price of a product is altered.
● It helps to determine the amount of losses that could be sustained if there is a sales downturn
How to calculate break-even point (BEP) ?
Key Factors in the formula for BEP includes:
✓ Fixed Costs are costs that do not change with varying output (e.g., salary, rent, building machinery).
✓ Sales Price per Unit is the selling price (unit selling price) per unit.
✓ Variable costs are the cost of raw material, fuel expense, direct labor cost, etc.
There are two methods to calculate break-even point, they are :
● Based on units:
Break-Even Point =
(in Units)
Fixed Costs
Sales Per Unit – Variables Costs Per Unit
● Based on sales:
Break-Even Point =
(in Sales)
Fixed Costs
Contribution Margin Percentage
Let’s understand it better with an example:
Colin is the managerial accountant in charge of Company A, which sells water bottles. He previously determined that the fixed costs of Company A consist of property taxes, a lease, and executive salaries, which add up to AED 100,000. The variable cost associated with producing one water bottle is AED 2 per unit. The water bottle is sold at a premium price of AED 12. To determine the break-even point of Company A’s premium water bottle:
Break Even Quantity = AED100,000 / (AED12 – AED2) = 10,000 Nos
Therefore, given the fixed costs, variable costs, and selling price of the water bottles, Company A would need to sell 10,000 units of water bottles to break even.
Contribution Margin = (Sales – Variable Costs) / Sales *100
= (12- 2) / 12 * 100 = 83.33%
Break Even Sales = AED100,000 / 83.33% = AED 120,000
Graphically Representing the Break Even Point :
The graphical representation of unit sales and AED sales needed to break even is referred to as the break-even chart or Cost Volume Profit (CVP) graph. Below is the CVP graph of the example above:
Conclusion :
Now you have a clear understanding of what the break-even point is and how to calculate it, it’s easy to see that the decisions you make about how you’ll operate your business, price your products, and reach your sales goals are linked.
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