Simply put, the Break-Even Point (BEP) can be easily defined, but the calculation can be elusive. BEP can be described as a point where there is no profit on loss, when sales covers variable and fixed expenses.
To calculate the BEP we need to understand what makes up fixed costs and variable costs in the business. Fixed cost are those that don’t change directly with the changes in sales volume. Examples of fixed costs are rent, office salaries, office expenses, interest expense, and other expenses that are not tied directly to the sales output. Variable costs change along with sales output. Examples of variable costs includes production wages, materiel costs, commissions and other expenses directly tied to sales output.
As an example, let’s assume a business is started when the fixed costs are $30,000 and the variable costs are $2.25 per unit sold. The expected sales price per unit is $3.00 How many units does the business need to sell for it to break-even?
BEP in Units:
- BEP in units = Fixed Cost / (price of product – variable cost per unit)
- BEP in units = $30,000 / ($3.00 – $2.25)
- BEP in units = $30,000 / $0.75
- BEP in units = $40,000 units
BEP in Dollars:
- Sales = 40,000 X 3.00 $120,000
- Less : Variable costs (2.25 X 40,000) < 90,000 >
- : Fixed Costs < 30,000 >
- Net Income (loss) $0.00
Not all costs are easily labeled fixed or variable costs, so additional analysis is needed when determining BEP. However, it is worth the effort. Once the BEP is determined, decisions like if we reduce our fixed or variable costs – how much can we reduce our price to be more competitive, or, if we are increasing costs – how much should we increase our product price. At worst case, a decision could be made that we simply cannot compete. On the other end of the decision, we can analyze how many more units would we have to sell if we reduced our sales price. It could occur that the sales price reduction could increase our unit sold to improve our profitability. Knowing what it would take to benefit from changes in costs on sales price allows the business leaders to make the best informed decision.
The above is a brief introduction to break-even analysis. Understanding Break-Even point allows you to play with various scenarios to forecast profitability, and analyze needed outcomes for reasonableness.
Break-Even Analysis is an ever changing thing, it is never final. There are countless factors that impact the components of a product being sold. But, Break-Even Analysis allows you to quickly run the numbers for you to make the best decision possible.