What is the Break Even Point Formula?
Definition: Break even formula refers to the stage at which the businesses, company, product or service will be profitable. This financial tool is important in helping the company or business to determine the number of goods and services it should sell so that it can cover costs such as fixed costs. In essence, this is when you are not making cash nor is the business losing cash but all fixed costs are covered.
Below the break-even point, the company will not be making adequate money to cover its costs. On the other hand above the break-even point, the company will be making profits in different ranges. This analysis tool helps the business to examine which will be the safe stage from the break-even point that can help the business to grow and be profitable. Here is a graphical representation example of break-even point analysis
The business is able to determine the safety margin through comparison of the number of units the business has to sell or amount needed to cover for variable and fixed costs relative to making sales. It is simply a comparison of total costs to the company’s total revenue to determine when it will be profitable. The analysis also helps managers to determine the amount of work and turnover necessary for the company to stay above the safety zone.
How to Calculate Break Even Point Formula
The formula for calculating break-even point analysis entails dividing aggregate fixed production costs by the sales price of each unit minus the variable expenses of producing the product.
Fixed costs which often referred to as overhead costs include the expenses the company incurs regardless of the number of product units it produces. These costs have to be paid regardless of whether the company is producing products or not or if it is making profits or losses. They include rent, taxes, salaries, labor costs, depreciation expenses, interest, and energy cost among others.
Variable costs, on the other hand, are expenses that are related to the decrease or increase in production volume. If the company’s production volume increases they will increase if it decreases they will reduce. They include things like packaging, fuel, raw materials and other expenses related directly to production.
Usually, the difference between the sales price of each unit and the variable cost for every unit is referred to as contribution margin and thus the break-even analysis formula can be simplified as:
How to Find Break Even Point? Explained
For a company is important to know its break-even pint because it informs the number of losses a business can withstand without doing further damage. Using this analysis provides business owners with insight and a clear picture of the ability of their business to make a profit. There is always a link between the various expenses a company incurs and the revenue it is generating. If fixed costs are high then it means the business’s break-even point will be higher but if the fixed costs are low then the business will break-even faster.
Businesses want to always stay above or at the break-even because this way it is easier to make changes to be profitable. Similarly, keeping at this level helps the business to cater for the fixed cost even if it is not making a profit. The break-even point analysis is a very important aspect in the stability of a company. Investors or the company can use the formula in calculating the amount of funding required to enhance growth as well as make the business profitable.
Summary
The break-even point analysis is an important aspect of business that helps in determining the level at which the company can be profitable. Similarly, it can help in ascertaining how the sales prices could impact on profits. Using this tool can also help the business cut on losses and help optimize the potential for returns on sales.