Break-even Analysis: How to Calculate the Break-even Point in Business?

The break-even point (BEP) is an important milestone for a business. It is a point where your expenses or investments are equal to your revenue, implying you’ve recovered your initial investment in the business. Breakeven is a point after which a business can strategise using their experience and finally take calculated risks to make headway into a profit-making zone.

There are two ways the break-even point can be calculated, i.e., based on units sold or sales. The break-even point differs for every industry, and in this article, we’ll learn how to calculate break-even points using different formulae based on the industry.

Break-even Analysis [Formula]

In basic terminology, the break-even price is the sum of monetary receipt equal to the sum of monetary contribution irrespective of the transaction domain. This can apply widely, including a housing sale, a home-based business, manufacturing unit, and service industry, to name a few.

The basic formula for break-even point is as follows:

Business Break-Even = Gross Profit Margin / Fixed Costs

The gross profit margin is calculated from the net sales minus the cost of the goods sold. Fixed costs include the static cost of goods like rent and investment of machinery, among others.

To calculate a break-even point in units, this is the formula:

Break-Even Point in Units = Fixed Costs / (Sales per Unit - Variable Cost per Unit)

Fixed costs will usually not change irrespective of the number of units produced and/or sold, and variable costs will include components like materials and labour.

To calculate the break-even point in sales, use this formula:

Break-Even Point = Fixed Costs / Contribution Margin

The contribution margin is the difference between the price of the product and variable costs.

Break-even analysis

This is an important step for planning ahead in the business, where you can strategise how to reach the break-even point and then move ahead to make a profit. Once the break-even point is calculated, it should be applied to the workable tasks.

Businesses must perform a break-even analysis beforehand to understand better if their product or service may turn profitable and justify the costs. It is also applied to many daily operations and is not limited to a product launch or start-up planning.

Break-Even Point [Example]

Suppose a factory business is selling goods. Here is a breakdown of the expenses and eventually calculating the break-even point.

Fixed costs for producing the goods = INR 60,000

Variable costs for the factory (approximately) = INR 2500

Cost per product = INR 100

Break-even = 60000/(2500-100) = 25

The factory would have to sell 25 units to come close to the break-even point. After this, they can plan to sell in a way that incurs more profit and take risks accordingly.

Break-Even Price Strategy

Most companies now do strategic planning in the initial stages before rolling out the business. The break-even point calculation can bring forth a volley of options. Below are some of the important strategic points that you can focus on in the break-even analysis.

1. Analyse the volume of products to sell

The break-even point can provide a good insight into how many units need to be sold for the business to recover its initial costs, including fixed and variable costs. Based on this calculation, they can regulate and phase out the production of units to avoid incurring any losses.

2. Planning budget

As we had seen in the previous section, we can calculate the break-even point in units as well as in sales. If it is calculated using sales, you can get a good view of the budget and plan the production based on this number.

3. Controlling expenses

Fixed costs and variable costs directly affect the profit margins. However, the break-even analysis gives the business time to check the effects of controlling these costs. In this way, the expenses can be controlled to create a profit scenario.

4. Pricing strategy

The break-even point is inversely affected by price. So, depending on the market, budget, and other important factors, prices can be regulated to achieve an early break-even point. Alternatively, if the pricing needs to be reduced, the business can plan accordingly to increase production as it will need more units to be produced to break even.

5. Safety Margin

In an unforeseen scenario or financial crisis, the break-even analysis can provide great insight. It can help the business decide how to regulate the production or design the budget to prevent the company from running into losses.

Break-Even Planning and Effects

The break-even analysis is an insightful analysis, and its computation has a range of benefits. Break-even planning is not restrictive and can be applied to many scenarios like the following:

• New business: Break-even analysis can provide guidance to strategise the budget, pricing, and overall productivity in planning a new business.
• New product launch: Even for an existing company, a new product launch can bring in many challenges. The break-even analysis can give the necessary grounding to the approach and ensure that it does not lead to unforeseen expenses for the company.
• Business model: If a business plans to change its working model or convert from retail to wholesale or any other scenario, the break-even point can provide a clear view of what additional costs could be incurred. It also shows how much planning is required before the business begins to make a profit.

Conclusion

Going by the market trends and experiences over the years, there is an increased awareness about business planning and strategy. A risk is taken by a business only when it is supported with adequate information and analysis. The break-even point calculation can therefore be a huge milestone for an existing as well as a new business. If a business is not doing well, it can use this break-even point calculation to mitigate its risks. It can help them understand how much money could be saved if they planned well.

By learning how to calculate the break-even point in units or sales, the company can decide their approach on how much time or production they would need before they start making a profit. In a world of uncertainties, the break-even point is a much-needed measure for an organisation or an individual business to determine the duration before they can achieve a sizeable profit margin.

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FAQs

Q. Which factors impact a break-even point?

Ans. The production cost of a company and the expected sales directly affect the break-even point calculation.

Q. What is the contribution margin? How does it affect the BEP?

Ans. The contribution margin is the difference between the variable costs and the product price. It is inversely proportional to the break-even point.

Q. What predictions can be made with the BEP calculation?

Ans. BEP calculations can predict the number of units that a business needs to sell before recovering the initial costs. It can also indicate how many sales need to be made in the initial stages to recover the initial investments made in the business.

Q. What does a negative break-even point indicate?

Ans. Negative BEP indicates that the cost of initiating a business is too high compared to the predicted sales amount. The budget planning should be revised, and the product launch may need more research.