Break-even Point

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Calculation of the point at which the gains equal the losses.

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Break-even Analysis

The Break-even Point is, in general, the point at which the gains equal the losses. A break-even point defines when an investment will generate a positive return. The point where sales or revenues equal expenses. Or also the point where total costs equal total revenues. There is no profit made or loss incurred at the break-even point. This is important for anyone that manages a business, since the break-even point is the lower limit of profit when prices are set and margins are determined.


Achieving Break-even today does not return the losses occurred in the past. Also it does not build up a reserve for future losses. And finally it does not provide a return on your investment (the reward for exposure to risk).


The Break-even method can be applied to a product, an investment, or the entire company's operations and is also used in the options world. In options, the Break-even Point is the market price that a stock must reach for option buyers to avoid a loss if they exercise. For a Call, it is the strike price plus the premium paid. For a Put, it is the strike price minus the premium paid.


The relationship between fixed costs, variable costs and returns

Break-even analysis is a useful tool to study the relationship between fixed costs, variable costs and returns. The Break-even Point defines when an investment will generate a positive return. It can be viewed graphically or with simple mathematics. Break-even analysis calculates the volume of production at a given price necessary to cover all costs. Break-even price analysis calculates the price necessary at a given level of production to cover all costs. To explain how break-even analysis works, it is necessary to define the cost items.

Fixed costs, which are incurred after the decision to enter into a business activity is made, are not directly related to the level of production. Fixed costs include, but are not limited to, depreciation on equipment, interest costs, taxes and general overhead expenses. Total fixed costs are the sum of the fixed costs.

Variable costs change in direct relation to volume of output. They may include cost of goods sold or production expenses, such as labor and electricity costs, feed, fuel, veterinary, irrigation and other expenses directly related to the production of a commodity or investment in a capital asset. Total variable costs (TVC) are the sum of the variable costs for the specified level of production or output. Average variable costs are the variable costs per unit of output or of TVC divided by units of output.

The Break-even Point analysis must not be mistaken for the Payback Period, the time it takes to recover an investment.


In Value Based Management terms, a break-even point should be defined as the Operating Profit margin level at which the business / investment is earning exactly the minimum acceptable Rate of Return, that is, its total cost of capital.


Break-even Point calculation

Calculation of the BEP can be done using the following formula:


BEP = TFC / (SUP - VCUP)


where:

  • BEP   = break-even point (units of production)
  • TFC    = total fixed costs,
  • VCUP = variable costs per unit of production,
  • SUP   = selling price per unit of production.

Benefits of Break-even Analysis

The main advantage of break-even analysis is that it explains the relationship between cost, production volume and returns. It can be extended to show how changes in fixed cost-variable cost relationships, in commodity prices, or in revenues, will affect profit levels and break-even points. Break-even analysis is most useful when used with partial budgeting or capital budgeting techniques. The major benefit to using break-even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.


Limitations of break-even analysis

  • It is best suited to the analysis of one product at a time;
  • It may be difficult to classify a cost as all variable or all fixed; and
  • There may be a tendency to continue to use a break-even analysis after the cost and income functions have changed.

Book: Marcell Schweitzer - Break-Even Analyses: Basic Model, Variants, Extensions -




Break-even Analysis Forum (22 topics) Help
  How to Use the Break-even Analysis in Negotiations with a Supplier?  - Hi folks, I am working on an assignment and got stuck with this: suppose you know the break-even point of a supplier, how can this information be used in negotiation? There are supposed to be several ...      
  How does a Grocery Shop Break Even?  - Could someone help me with the methodical approach towards cost analysis in a grocery shop. Please tell me how the Break Even Point (BEP) of such a business entity is calculated, given the hundreds of...      
  How to Account for Interest in Break-even Point Calculation?  - Hi, I am clueless as to how to calculate BEP when other operating expenses such as interest are involved. How is interest considered in the formula for BEP calculation?...      
  Break-even Point Analysis when Material Prices Fluctuate  - How realistic is the adoption of Break-even Point Analysis (BEPA), when the price level of materials fluctuate a lot?
Is there a way to adopt BEPA so it can accommodate frequent and considerable ...
     
  Could There Be 2 or even more Break Even Points?  - The main article considers the simplest case, when the function TC (total cost) grows linearly (y=ax+b).
But we can image a different non-linear mathematical law describing the costs (y=ax^2+c or...
     
  Break-even Point Example  - Suppose my sales turnover for a new product line (multiple products) is $82,000 and my purchase is $75,000. My minimum margin is 20 % before tax.
However, my fixed cost are about $18,000, variabl...
     
  BEP Calculation Possible with Multiple Products?  - If you have multiple products with hardly any variable cost, would BEP calculation still be an option?
I have 40 lines and do not know how many products will sell. I only have a fixed expense bei...
     
  Breakeven Formula for Services  - What is the formula for calculating the breakeven point in a services entity?...      
  Break Even Point Calculation of a Bank  - I would like to know that how can I calculate the break even point of my bank? What will be the formula for that & what will be the basis for taht calcualtion?
My objective is to determine the mi...
     
  Breakeven Point Calculation  - Suppose my fixed cost for year 2011 is $1m. If my markup is 20%, what is my breakeven point in dollar. My business is roofing contractor....      

See 12 more topics



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