Break-even Point Analysis

Break-even Point Analysis

The Break-even Analysis is the technique used by management to calculate their monthly or annual sale or returns, to cover their costs. The break-even point is that point at which gains equal the losses. It is the point where the total costs equal total revenues. The break-even point helps calculate the minimum profit for a business, when setting margins. It helps determine after what point a business will earn a profit. The break-even point analysis is often mistaken for the Payback Period which is the time taken to recover an investment. Costs A number or costs must be taken into account when performing a break-even analysis. A brief description of the types of costs is given below. The total production costs are categorised into fixed variable and mixed costs. Fixed Costs: Fixed costs are costs that must be incurred irrespective of the quantity of produce. This implies that whether it’s a single product or bulk production, the fixed costs still remain the same. Some examples of fixed costs are research and development costs, rent, insurance, administration, marketing costs, etc. Variable Costs: Variable costs are those costs that depend directly or indirectly on the quantity of produce. Some of these variable costs like raw materials, machinery, labour costs are direct costs while costs such as maintenance of machinery, depreciation are examples of indirect variable costs. Mixed Expenses: Certain expenses are mixed in nature i.e. a portion of it is fixed, while a portion is variable. These expenses are called mixed expenses or semi-variable expenses. These kind of expenses are very common and can be used by adding its fixed component to the total fixed expenses and its variable component to the total variable expenses. The Breakeven Calculation Calculation of break-even point is fairly simple and straightforward. It involves numbers such as your fixed and variable expenses and the selling price per production unit. It can be calculated as The number obtained by this calculation tells you the number of units of the product you will have to sell to recover all expenses, fixed and variable, spent during production. Every unit of product sold after this breakeven point is a profit for the organization. You may even identify your target profit, and work backwards, to calculate the number of units of product that have to be sold to reach that mark. For e.g., if the selling price of your product is USD 10 and its fixed expenses are USD 1000, while variable expenses are USD 5, then the breakeven point is 500 units. This means that you will have to sell at least 500 units of your product to return all your expenditure. Any sale of units of product over 500 may be considered as a profit for the company. A number of tools are available online that can help you with your breakeven point analysis and make these calculations easier and faster for you. Limitations of Break Even Analysis Any past or future losses cannot be made up for with a current breakeven. It is sometimes difficult to gather the information required for breakeven analysis, especially the variable expenses. It is even more difficult to classify expenses into the fixed or variable. Breakeven analysis can best analyse one product at a time. This calculation also assumes that the number of products produced and sold remains the same. It also assumes that all the products will be sold at the same price. Based on the response to a product, the company may have to increase or decrease its price.