Concept of Breakeven Point
Break Even Point is the minimum level of production and sale at which the unit will run on ” no profit, no loss.” The first goal of any project would be to reach at Break Even Point. This is the point where the losses of the project ceases and the profits begins to accrue.
Break Even point is useful to estimate the time of projected the cost of production and sales. In a Break Even point the total sales are equal to the total cost including interest and amortization of long term finance.
Formulas to Calculate Breakeven Point (BEP)
- Break Even Point (in units) = Fixed Costs/Contribution Per Unit
- Break Even Point (in units) = BEP in Sales value/Selling Price Per unit
- Break Even Point (in $) = (Fixed Cost * Selling Price per unit)/Contribution Per Unit
- Break Even Point (in $) = (Fixed Costs/Contribution Per Unit)* Sales
- Break Even Point (in $) = Fixed Cost/PV Ratio
- Break Even Point (in $) = Sales – Margin of Safety
Assumptions to Calculate BEP
- It Can only apply to a single product
- Fixed costs and variable costs are constant
- Sales prices are constant at all levels of activity
- Total Production = Total Sales
Advantages of Breakeven Point Analysis
Break Even point helps to :
- measure the profit and losses at different level of production and sales
- forecast the possible effect of changes in sales prices
- coordinate the relationship between fixed and variable costs
- forecast the effect of cost and efficiency changes on profitablility
Disadvantages of Break Even Point Analysis
- It assumes that sales prices are constant at all levels of output which are not realistic
- It assumes production and sales are the same at all the time which is impractical
- Break Even chart may be time consuming to prepare
- It only apply to a single product or single mix of products
Breakeven Point and Stock Market
Suppose, you are the investor of stock market and buys the stock of a reputed company at $ 120. This $ 120 is the break even point. If the stock price moves above $ 120, you will make money. if the stock price drops below $ 120, you will lose money. If the price remains at $ 120, it will be said as BEP, because at this point you remain at no loss or not profit point.
From the following information determine the Break-Even Point in terms of units and sales value:
Output 4000 Units
Selling Price Per Unit $20
Variable Cost Per Unit $12
Total Fixed Costs 40,000
Break Even Point (in Units) = Total Fixed Costs/ Contribution Per Unit
= $40000/ 20-12 = 5,000 units (used Formula 1)
Break Even Point (in Sales Value) = Total Fixed Costs/PV Ratio = 40000/40% =
$100,000 (Using Formula 5)
PV Ratio = (Selling Price Per unit – Variable Cost Per Unit)/Selling Price Per unit
= (20-12)/20 *100 = 40%
Break Even Point and Production Department
Production Department and sales executives have to be conscious of the level of sales and the management is concern how they could covering the fixed and variable costs at all times. That’s the reason they frequently try to change the components of formula to reducing the number of units to produce and try to increase the profitability of the business.
Say for example, if management decides to enhance the sales price of the product , it would have severe impact on the number of units required to sell before profitability. They may also change the variable costs for each units by adding more updated technology to the production process. Lower variable costs equate to greater profits per unit and reduce the total number that must be produced. If any company taking outsourcing strategy, it may also change the cost structure.
The experienced businessman uses his break-even charts to indicate profit margins at a given rate of production. However, the chart is useful only when fixed costs remain the same, when variable costs can be changed with reasonable production changes, and this is assumed the company produces only a single item.