Breakeven point is one of the important concepts frequently mentioned in the investment and business plans of companies. In this article, Eud Academy Business School will help you understand more about what the breakeven point is and how to calculate it.
1. What Is Breakeven Point?
The breakeven point is the average value of an investment at which you neither incur losses nor make profits. It helps you determine when you will start to profit from your investment.
Breakeven cost is an economic and accounting concept, representing the value of an investment at which revenue equals costs, meaning there are no losses or profits. Breakeven cost is often used to evaluate the effectiveness of an investment or a business project.
2. How to Calculate Breakeven Point
There are two commonly used methods to calculate the breakeven point. Below are the two most accurate and straightforward methods.
2.1. Equation Method
The equation method is based on an expression that demonstrates the relationship in CVP (Cost-Volume-Profit) analysis. Therefore, we have the following formula:
Profit – (Revenue – Variable Costs) – Fixed Costs
Or it can be rearranged as:
Revenue – Variable Costs + Fixed Costs + Profit (Formula 1)
Profit at the breakeven point is always equal to 0. Thus, we can rearrange the formula as follows:
Revenue – Variable Costs + Fixed Costs (Formula 2)
Formula 2 is known as the breakeven expression.
From formula 2, you can calculate the quantity of products to be sold to breakeven. You can also easily calculate the breakeven revenue.
Breakeven Quantity = Fixed Costs / (Price – Variable Costs)
Breakeven Revenue Calculation = Price x Breakeven Quantity
2.2. Graphical Method
By definition, at the breakeven point, revenue equals total costs, and profit equals 0. Therefore, the intersection of revenue and total costs is the breakeven point.
3. Some Cost-related Concepts
3.1. Fixed Costs
Fixed costs are expenses that a business must pay regularly and do not change with the level of business activity. Examples include rent, salaries, insurance, depreciation of fixed assets, etc. Fixed costs affect a company's profit and business efficiency. They can be classified based on management method, allocation method, and degree.
3.2. Variable Costs
Variable costs are expenses that change with the level of business activity, typically with changes in product quantity. When producing an additional unit of a product, variable costs increase, and vice versa. Examples include raw material costs, labor costs, energy costs, sales commissions, etc. Variable costs impact a company's profit and need to be managed efficiently.
4. Example of Breakeven Point Calculation
Company A is a garment manufacturer with total fixed costs of $100,000, an average selling price of one garment at $100, and an average variable cost per garment of $50. Applying the breakeven point formula:
Breakeven Quantity = $100,000 / ($100 - $50) = 2,000 garments
This means that Company A must produce and sell at least 2,000 garments to avoid losses. If Company A produces and sells fewer than 2,000 products, it will not cover all its costs and will incur losses.
However, when calculating the breakeven point, companies need to consider other costs related to production and business activities, such as advertising expenses, maintenance costs, financial costs, taxes, and other costs when making sound business decisions.
5. Why Is Breakeven Point Important?
A business may generate very high profits but still incur losses. The breakeven point allows businesses to determine at what level of consumption or revenue they break even. Therefore, knowing the breakeven point is crucial for pricing decisions, setting sales budgets, and preparing business plans. Calculating the breakeven point is a valuable tool for analyzing the critical factors driving a company's profitability.
Monitoring a company's breakeven point helps you understand:
How profitable your current product line is.
How much sales can decrease before you start incurring losses.
How many units need to be sold to break even or to generate a profit.
How changes in prices, product quantities, cost structures affect the company's profitability.
How much price increases, increased product consumption, or reduced variable costs are needed to offset increased fixed costs.
The breakeven point is one of the critical factors in financial analysis for businesses. This article has summarized all the knowledge about the breakeven point. Eud Academy Business School hopes that this blog has provided you and your business with comprehensive information and useful knowledge regarding breakeven point-related factors.
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