Break-even Point
Break-even Analysis

Calculation of the point at which the gains equal the losses. Explanation of Break-even Point Analysis.



  

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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 Special Interest Group


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Break-even Analysis Forum

Recent User Comments
Jagadish - India Break Even Point formula for a service industry "What will be the basis and formula to anaylse the break even point for a service industry with manpower supply"    5
Gaurav - India Shut Down Break-even Point? "Can anybody tell what is a "shut down BEP" and how it is calculated?"    1
Zilla Asare - Ghana Further Limitations of Break Even Analysis "Are there any other / more disadvantages or limitations of break even analysis?"    9
 - SA BEP Useful for New / Start-up Businesses "BEP is also very useful for new / start-up businesses because it allows them to gauge whether the resources and capacity they have or can acquire will meet the minimum business activity necessary for them to break even."    -2
Yigalem Tadele - Ethiopia How to Calculate BEP Without Price Given? "In BEP, if the price is not given, how am I going to calculate BEP?"    15
Best User Comments
Jawett - USA Time after Break-even Point? "What is the point/period called after the break-even point when the business starts generating a profit?"    32
Neeraj - India Time for break even.. "Generally, what is the minimum time to achieve break even for a company?"    8
India - Ashutosh Break Even for Projects "If in the initial years of a project it is under deficit, then what are the aspects to cover, in order to get an idea about break even point for the project? And also how to calculate the break even point for such projects?"    6
jianping Wang - China Contribution "What's the meaning of the phrase of "contribution " when refering to the break-even point?"    4
Pete - US Break Even Point "If one compares the break even point over 2 different time periods for the same entity but on different cost structures (variable and fixed) and different sales , how do you measure improvement in Break Even point ?"    3
Anne-Laure - France Not enough revenues...? "What should I normally do if the revenues do not cover the fixed and variable costs? What should I do if the revenues do not even cover the fixed costs?"    3
Ingrid - New Zealand Owners withdrawals "Can you tell me if owners withdrawals (drawings) are included in fixed costs in CVP and break-even analysis? Also, If an owner transfer's a building into the business, would you include this item in the cash flow statement? (which is related to cvp analysis after all...) Thanks!"    2
sadik - Oman Break- even "thank u very mach this is very important to all business, I think that ."    2
Iqbal - Sheriff Gause-Jordon method "Thanks for your good explanation. Can you please explain about Gause-Jordon method the following equation x1+2x2 = 8 ; 3x1+ X2 = 9"    -1
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Copyright 2009 12manage - The Executive Fast Track. V10.4 - Last updated: 11/21/2009. All names tm by their owners.

  ● Ayaz Nasim (Pakistan) Performance Measurement "The formula of break even point as above."
  ●  (France) BEP "It's the same as pointed hereinabove on this page"

  ● Mason (USA) Shutdown BEP "Gaurav, The shutdown condition is a LOSS of the Fixed Costs. If all other variable expenses are eliminated and employees are laid off, you will still be paying the Fixed costs such as insurance on the building and writing off the depreciation expense on the equipment, until everything is sold or liquidated."



  ● Gaurav (India) How to Calculate Bep Without Price "If the price is not given, but the 2 different levels of sales and total revenue are given, then you can find out the % of variable cost based on the difference between sales and total cost
For more detail you can call, Gaurav 09825928754"

  ● Shelldince (India) Time after Break Even Point "The Time after the Break Even Point is called: 'Post Break Even Point'."
  ● Erik Fabian (USA) Time after Break-even Point... "It is called party time!"
  ● Egbayelo G.Monday (Nigeria) Management Accounting "The break even analysis is supposed to be ellaborated on very well, ie-the contribution, the profit, margin of safety, budgeted profit etc. ACIA NIG."BREAKTHROUGH TIME""
  ● Evans Matuto (USA / Kenya) Cost Accounting "Margin of safety."

  ● Rajaram Segaram (Malaysia) Time period taken for break even "The guideline for determing how long a break even period should take depends on the payback period. This the duration that a company takes to recoup its original investment. As an example if the payback period is 3 years then a firm should break even approximately by the 3rd year ."
  ● Ludmila (Ukraine) BEP "Would it be correct if we will extent BEP for evaluation of activitiy of each separate departments (not entirely company)? Especially, for department which provides support service in order to create core competencies of the whole company?"


  ● M Manjunath (India) Economics "It is equal to per unit price minus per unit variable cost. It is the contribution the revenue or sale price makes towards covering fixed cost and profit, if any."
  ●  (México) Meaning of Contribution "The word 'contribution' when refering to a break even point consists in generating of profits. It is the profit of each one of the products. It is convenient because your level of productions begin to create profits and it is very important because you can and you must know the contribution of each product."

  ● shoakat (UK) BEP "I think BEP should only relate to fixed costs as the idea is once they have been recovered, each additional unit of output is generating extra income. Different sales figures are irrelevant in terms of variable costs however with each additional unit of output would reduce fixed cost per unit."

  ● Godon (USA) Not enough revenues "Having been in this situation recently in our own business I offer this; project forward the P/L, one year, even at the high level numbers. make several versions, optimistic, pessimistic, best guess, or most likely. If the trend is up you may be able to borrow, get a line of credit or factor your accounts receivables. If the trend is down or no change, then yo look to cut overheads, by sub leasing assets or property not used, substitute staff with your own efforts, (is it your company, i am making that assumption.) Address the revenues, go get more business. Address Act Rec, put pressure on customers to collect. Let everyone know in the company that their income depends on urgent and coordinated effort. Good luck Gordon"
  ●  (Brazil) See marketing planning "As the first activity, review the marketing plan and change the marketing approuch. The problem can be: seasonality of demand, competing product more attractive, product price and others .."
  ● pradeep deo (India) Break Even Analysis-Not Enough Revenues. "I would suggest to Anne-Laure -France-that in such a situation pl .explore the possibility of applying Lean Management Practice, developed by Toyata -Japan , which addresses (a) Reduction of Waste(b) Variability and (c) flexibility simultaniously for operational efficiency improvement.."
  ● Luciano Bergamaschini (Italy) Not enough revenues "Causes may be many and must be investigated (sales policy, low sales, commitment of possible distributors, of sellers, high costs, distribution costs too high, etc). One of the key strategic points however is to exactly define what business you are in, e.g. food or health, medical devices or healthcare, chemical or cosmetics, etc. This may lead to open wider perspectives for the business and to redefine the "value proposition" and the company positioning on markets complementary to the current one."
  ● Richard D. Cushing (USA) Not enough revenues "You will get a much clearer picture of your situation if you back away from "variable costs" (allocations) and break down your numbers in this way: Revenues (R) = as normally defined Truly Variable Costs (TVC) = those costs (typically raw materials, outside services and commissions) that truly and actually vary in an absolute and direct correlation with the revenues Operating Expenses (OE) = everything you pay out day-after-day or month-after-month that is not truly variable with revenue (this includes wage or salary labor that may work in producing revenue but their wages are not truly variable with the production of a unit of revenue) Now, Throughput (T) = R - TVC If T > OE, you are making some profit. Identify your CONSTRAINT to increasing T. Remember, once you know the per-unit value of T for any product or product line, any R > TVC will produce some profit, provided the aggregate of T > OE. Does your organization have enough CAPACITY to produce sufficient T to exceed the value of OE?"
  ●  (USA) Not enough revenues "What Gordon suggest is what I would do in a low revenue situation. Additions can be the use of tools to reduce expenses or cost suggested by others, as well as ways to leverage cash, not the least to consider of course."
  ● vincent (India) Not enough revenue "A lot of variables that goes into the operation have to be relooked into in terms of cost cuttingor waste reduction/mangement in the case of expenses both variable and fixed and capacity enhancement in the case of revenue not only in production and also in market capacity to absorbe the additional quantity or price as the case may be."
  ● Vivek (India) Not enough revenue "have seen this situation quite a few times in small & medium enterprises (SMEs). First, make your projections (optimistic, realistic, psessimistic) for revenue and drill down to bottom-line. Next (& perhaps more critical for SME), drill down to cash flow at least quarter by quarter. Revenue in P/L is Maya, cash outflow is reality. If cash flow is positive, you can allocate resources for a) sales growth b) new business areas. Pls do a detailed cash flow for the new business also. If cash flow is negative, attack the fixed cash expenses ruthlessly. Borrowings need to be channelled towards increasing your top line, as that is the only sustainable approach. If Anne-Laure runs an SME, the environment todays is extremely challenging for SMEs. Focus on minimum fixed expenses, do not stop at P/L and do C/F analysis, and aim for a situation such that high probability cash contribution match cash fixed expenses."
  ● Earl (USA) Develop a Variable (Flex) Budget "I would suggest developing a Variable (Flex) Budget to drive a definitive "Break-Even" during the Forecasting / Planning activity. Fixed Costs will remain constant (as they should) for this application, but, driving the Variable Costs will enable the user to develop a Break-Even point for current planning. Additionally, One will also have the capability to measure performance; i.e., "If Actual Performance is only %70 of a Perfect Month, then, what should my "Variable Costs" be in relation and within reason?"