The breakeven point is defined as the point where both total expenses and total revenues are equal to each other. It is the production level during a manufacturing process or an accounting period where revenues generated and expenses incurred are the same, and the net income for that period is zero.
In simple terms, it means that the organization neither earned any money nor lost it simply broke even.
Meaning of break-even point
Break-even point is considered a measurement tool that is used in cost accounting, business, and economics to determine the point when both the total cost and revenues are even.
Retailers use this key concept to understand how much units must be sold to meet the minimum costs, and manufacturers use it to calculate the number of units that must be manufactured and sold during this period.
Remember the break-even point matters a great deal as it is the point where the project or business or a product becomes financially viable.
The break-even calculation gives a company a view of the future. All costs that need to be paid are paid, for example, capital has received the expected return after risk-adjustment and opportunity costs have also been paid. At this point, the company does not show either loss or profits.
Suppose the company has reached its break-even point in November in the financial year 2018-19 the money earned from that period onwards will be its pure profits. The early you reach the break-even point, the more is your profit margins.
Uses of break-even point
The first goal of any company is to reach its break-even point as quickly and efficiently as it can. This is the level at which the loss ceases, and profits start accruing. The break-even point is useful in the following situations –
- To determine the loss that a business can sustain in case, it suffers from a dip in sales figures
- The concept is used in determining the impact on profit if automation which is a fixed cost replaces labor which is a variable cost
- It is useful to know about the changes that will occur in profit figures if the company alters the price of a product
- To determine the remaining capacity after you reach the break-even point as this will help the company to know about the maximum profit, it can generate
Factors that increase break-even point
The factors that can increase an organization’s break-even point are as follows-
#1. Increase in sales
If a company is showing an increase in its sales figures, it means that there is a high demand for the product.
To meet this demand, the organization will have to increase its production. This will increase the break-even point as it will have to cover the additional expenses
#2. Repairing of equipment
If production falters because of failure in equipment or machinery, it will take for repairs. This will put a halt to the units produced. As the target is not met within the stipulated time, the break-even point automatically increases
#3. Increase in production costs
In some cases, the demand for a product as well as the customer sales remains constant, but there is an increase in variable costs. It can be produced a cost, an increase in the price of raw materials that the company needs for manufacturing the product, an increase in salaries of the employees, increased rent of warehouses or higher utility rates.
When any of these things happen, the break-even point automatically increases due to the extra expenses that the company has to bear.
Factors that decrease break-even point
The factors that can decrease an organization’s break-even point and generate higher profits are as follows-
#1. Increasing product prices
Raising product prices is a sure way of decreasing the break-even point although most companies are hesitating to do so as they fear the loss of customers
#2. Margin analysis
It is vital to monitor the product margins and push up the sales of items with the highest margins. This will reduce the break-even point
Price reduction schemes increase the break-even point hence minimize the usage of vouchers and coupons in order to decrease the break-even point
#4. Opt for outsourcing
Sometimes the best way to decrease your manufacturing costs is by opting for outsourcing. This will also increase your production volumes and help in generating further revenues by decreasing the break-even point.
#5. Cost analysis
Reviewing all fixed costs and variable costs will help to determine whether they can be eliminated without harming the business. This increases margins and automatically decreases break-even point
Assumptions of break-even point
The assumptions of the breakeven point are as follows-
- The breakeven point tool can apply to a single product only
- Total production is equal to total sales
- The sales prices are considered to be constant at every level of activity
- The variable, as well as fixed costs, are considered constant
Examples of break-even point
XYZ Company has listed its selling price at 40 Rs per unit, output at 8000 units, variable costs at 24 Rs per unit and total fixed costs at Rs 80000. In order to determine its breakeven point, you need its formula which is
Break-even point (in units) = total fixed costs/contribution per unit
Break-even point (in units) = 80000/40-24
Break-even point (in units) = 5000 units
Break-even point (in sales value) = total fixed costs/PV ratio
The PV ratio is calculated as
PV ratio = (selling price per unit – variable cost per unit) / selling price per unit
PV ratio = (40-24) / 40
PV ratio = 16/40
PV ratio = 40%
Breakeven point (in sales value) = 80000/40%
Breakeven point (in sales value) = 200,000 Rs
Advantages of break-even point
The advantages of break-even point are as follows-
- The breakeven point concept gives an accurate estimate of the number of units that must be sold to start making actual profits for the organization
- The point helps to identify the variable and fixed costs and coordinate the relationship between them
- It is a measurement tool that is used effectively to set targets
- The breakeven point can predict the consequence of cost and efficiency changes on the profitability of a business.
- The breakeven point can help a company to calculate the profit and loss figures at various level of sales and production
- The organization uses a breakeven point to evaluate future demand. If the breakeven point is above estimated demand, it means a loss and the company might opt to discontinue the product or make viable changes to increase demand
- It helps to make a viable forecast about the probable effect of the change on the sales price
- The information provided by the breakeven point helps the management in making important decisions for example while applying for loans, in setting prices and while preparing competitive bids
Disadvantages of break-even point
The disadvantages of the breakeven point are as follows-
- The breakeven point is calculated on the assumption that revenue and costs will not change with output
- It assumes sales and production will remain the same at all the time and it is not a practical theory
- One of the limitations of a breakeven point calculation is that it can apply to a single product only and a company where you have several products finds it a hassle
- The supposition that sales price remains constant at every output level is impractical
- Creating break-even charts and deriving the breakeven point is a time-consuming process
- Sometimes the organization sets too high a target after calculating it via breakeven point formula and this can lead to stress