The Breakeven Point is, in general, the point at which the gains equal
the losses. A breakeven 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 breakeven point. This is important for anyone that
manages a business, since the breakeven point is the lower limit of profit
when prices are set and margins are determined.
Achieving Breakeven 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 Breakeven 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 Breakeven 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
Breakeven analysis is a useful tool to study the relationship between
fixed costs, variable costs and returns. The Breakeven Point defines when
an investment will generate a positive return. It can be viewed graphically
or with simple mathematics. Breakeven analysis calculates the volume of production
at a given price necessary to cover all costs. Breakeven price analysis calculates
the price necessary at a given level of production to cover all costs. To
explain how breakeven 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 Breakeven Point analysis must not be mistaken for the
Payback Period, the time it takes
to recover an investment.
In Value Based Management terms, a breakeven 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.
Breakeven Point calculation
Calculation of the BEP can be done using the following formula:
BEP = TFC / (SUP  VCUP)
where:
 BEP = breakeven point (units of production)
 TFC = total fixed costs,
 VCUP = variable costs per unit of production,
 SUP = selling price per unit of production.
Benefits of Breakeven Analysis
The main advantage of breakeven analysis is that it explains the relationship
between cost, production volume and returns. It can be extended to show how
changes in fixed costvariable cost relationships, in commodity prices, or
in revenues, will affect profit levels and breakeven points. Breakeven analysis
is most useful when used with partial budgeting or capital budgeting techniques.
The major benefit to using breakeven analysis is that it indicates the lowest
amount of business activity necessary to prevent losses.
Limitations of breakeven 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 breakeven analysis after
the cost and income functions have changed.
Book: Marcell Schweitzer
 BreakEven Analyses: Basic Model, Variants, Extensions
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