What is Break Even Point?
Definition: The break even point is a point where a business or an investor is not expected to make any loss or profit. It is essentially a point where the total costs of operations (expense) is equal to the total sales or revenues generated. In a business setting, it is a point in which sales generated can cover all the expenses incurred.
In the capital markets, you are likely to hear investors asking when they are likely to break even. As a crucial financial analysis tool, investors and business owners rely on the breakeven point to ascertain if an investment is expected to end in a loss or a profit.
Break Even Point Formula
The break even point formula is calculated by taking into consideration three key variables:
Fixed costs: These costs don’t change and are independent of sale volume but crucial to the production
Variable costs: These are costs that vary depending on the amount of volume that a company or business produces.
The selling price of a product
Break-Even Point = Fixed Cost / Gross profit margin ( Price – Variable Cost )
In this case, the formula provides the dollar amount needed to break even. However, it is also possible to calculate the number of units needed to break even. In this case, one needs to divide fixed costs with the difference between unit sale prices minus variable cost.
Break Even Point = Fixed Cost / Unit Sale Price – Variable Cost per Unit
How to Calculate Break Even Point Example
A breakeven point is used in a number of fields but with the same outcome. In accounting, the term refers to the production level at which the total amount of revenues that a business or company produces is equal to the total expenses.
Consider a company with fixed costs of about $500,000 and a gross margin of 20%. For the company to break even, it will have to generate goods worth $2.5 million.
Break Even Point = $550,000 / 0.2 = $2,500,000
Any revenues above $2.5 million would allow the company to cover all fixed and variable costs, consequently, generate a profit.
In investing, breakeven refers to the Point at which the market price of a security is equal to the original cost. For options traders, it is the Point at which a trader would be able to avoid or loss if they opt to exercise the option.
When an investor buys a stock, say at $200, the breakeven point, in this case, would be $100. The price moving above the $100 mark would translate to the investor, making a profit. Likewise, the price dropping below the $100 would translate to a loss.
Upon carrying out a breakeven analysis, you may realize that the current price is too low to break even. If that were the case, then raising the cost would be an appropriate call. However, it would be essential to check what other businesses are charging to avoid pricing oneself out of the market.
Break even analysis can also be relied upon to ascertain whether the cost of materials or labor is unsustainable. If that were the case, then it would be wise to carry out research on how to maintain the level of quality while lowering costs.
Break-Even Point Benefits
The breakeven point has proved to be a reliable financial analysis tool as managers use it to make essential business decisions. For instance, the metric can be used to set prices so that a company can be able to make a profit as well as for preparing competitive bids in tenders.
Break even analysis also allows managers to define the lowest quantity of sales that must come into play to cater for fixed and variable costs. The analysis also allows managers to know the quantity that can be used to evaluate future demand. The breakeven point also helps in ascertaining the relevance of both fixed and variable costs. A lower fixed cost with flexible personnel and equipment will always result in a lower breakeven point.