Break-even Point: Definition, Benefits, Drawbacks, and Examples
The Break-even point is the point at which both total expenses and total revenues equal each other. It is the amount of production during a manufacturing process or an accounting period when revenues and expenses are equal, and the net income for that period is zero.
Just put, it indicates that the company did not make any money or lose any money; it simply broke even.
What does the term "break-even point" mean?
The term "break-even point" refers to a measurement instrument used in cost accounting, business, and economics to define the point at which total costs and revenues are equal.
Manufacturers use this key concept to calculate the number of units that must be manufactured and sold during this period, and retailers use it to understand how many units must be sold to meet the minimum costs.
It's important to remember that the break-even point is the moment at which a project, business, or product becomes financially viable.
The break-even analysis provides a corporation with a glimpse into the future. All costs that must be paid are paid; for example, capital has received the projected return after risk adjustment, as well as opportunity costs. At this moment, the corporation has neither a profit nor a loss.
Assume the company's break-even point was reached in November of fiscal year 2018-19, and any money earned after that will be pure profits. The earlier you hit break-even, the higher your profit margins will be.
Any company's primary goal is to attain break-even as fast and efficiently as possible. This is the point at which the loss stops and profits begin to accumulate.
In the following cases, the break-even point is useful:
- To figure out how much of a loss a company can take in the event of a drop in sales.
- The notion is used to calculate the profit impact of replacing labor with automation, which is a variable cost.
- It's useful to be aware of the changes in profit figures that will occur if a company changes the price of a product.
- Determine the remaining capacity once you've reached break-even, as this will help the company figure out how much profit it can make.
Factors that contribute to a higher break-even point
The following are some of the reasons that can help an organization's break-even point rise:
1. A boost in sales
If a company's sales figures are increasing, it indicates that there is a great demand for the product.
The organization will have to raise output to meet this demand. Because it will have to cover the additional expenses, the break-even point will rise.
2. Equipment maintenance
It will take time for repairs if production is halted due to equipment or machinery failure. The units manufactured will come to a halt as a result of this. When a goal isn't met within the allotted time, the break-even point rises automatically.
3. Cost of production rises
The demand for a product, as well as customer sales, may remain constant in some cases, but variable costs may rise. It can be created at a cost, such as an increase in the price of raw materials required by the company to manufacture the product, an increase in staff pay, increased warehouse rent, or higher utility bills.
Because of the additional expenses that the corporation must incur when any of these things occur, the break-even point automatically rises.
Break-even point lowering factors
The following are some of the reasons that can lower an organization's break-even point and increase profits:
1. Increasing product prices
Raising product prices is a surefire way to lower the break-even threshold, however most businesses are wary of doing so for fear of losing clients.
2. Analysis of the margins
It's critical to keep an eye on product margins and boost sales of items with the best margins. The break-even point will be lowered as a result.
Pricing In order to lower the break-even point, price reduction schemes enhance the break-even point, reducing the use of vouchers and discounts.
3. Make the decision to outsource
Outsourcing is sometimes the most cost-effective strategy to reduce your manufacturing costs. This will also help you raise production quantities and generate more income by lowering the break-even point.
4. Analyze the costs
Examining all fixed and variable costs will aid in determining whether they can be removed without causing harm to the company. This raises profit margins and lowers the break-even point.
5. Break-even point assumptions
The following are the Break-even point assumptions:
- Only one product can be used with the Break-even point tool.
- Total sales are equivalent to total production.
- At all levels of activity, sales prices are assumed to be constant.
- Both the variable and fixed costs are treated as constants.
Break-even point examples
Total fixed costs/contribution per unit Equals break-even point (in units).
80000/40-24 = break-even point (in units)
(in units) Break-even point = 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%
Now,
Break-even point (in sales value) = 80000/40%
Break-even point (in sales value) = 200,000 Rs
Benefits of the break-even point
The following are some of the benefits of the break-even point:
The Break-even point notion provides an accurate estimate of the number of units that must be sold in order for the company to begin producing genuine profits.
The point aids in the identification of variable and fixed expenses, as well as the coordination of their relationships.
It's a measurement tool that may be used to properly set goals.
The Break-even point can be used to forecast the impact of cost and efficiency adjustments on a company's profitability.
The Break-even point can assist a business in calculating profit and loss figures at various sales and production levels.
To assess future demand, the company utilizes a Break-even point. If the Break-even threshold is higher than expected demand, the corporation will lose money and may decide to stop the product or make adjustments that would raise demand.
It aids in the estimation of the likely impact of the adjustment on the sales price.
The Break-even point provides information that assists management in making key decisions, such as when asking for loans, determining prices, and preparing competitive bids.
Break-even point disadvantages
The following are the drawbacks of the Break-even point:
The Break-even threshold is determined under the assumption that revenue and costs will remain constant regardless of output. It is not a practical theory because it implies sales and production will remain constant at all times.
One of the drawbacks of a Break-even point calculation is that it only applies to a single product, which makes it difficult for a corporation with multiple goods.
The assumption that sales prices remain constant at all levels of output is unrealistic.
Creating break-even charts and calculating the Break-even point takes time.
When an organization calculates a target using the Break-even point calculation, it may establish a target that is excessively high, causing stress.
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