What is the breakeven point? (definition, utility, calculation and analysis)

Break-even point (also known as deadlock) is a business term that refers to the point of activity where income equals cost; that is, at the point of activity where there is no gain or loss.

Knowing the equilibrium point of a company allows us to know the level or volume of sales where the income is equal to the costs and thus, for example, to know how much we have to sell to cover our costs, or how much we we have to sell to start generating profits.

The analysis of the equilibrium point of a company, in general terms, allows us to analyze it financially and thus, based on said analysis, to be able to make decisions.

In this article you will find:

  • What is the breakeven point?
  • What is the utility of the break-even point?
  • How to calculate and analyze the breakeven point?
  • Example of how to calculate and analyze the breakeven point
  • Summary

What is the breakeven point?

The equilibrium point (also known as deadlock) is a business term (being specific, typical of cost accounting ) that refers to the point of activity where income is equal to cost; that is, at the point of activity where there is no gain or loss.

In the case of a company, the break-even point refers to the level or volume of sales where the income is equal to the costs and, therefore, to the level or volume of sales where there is no profit or loss.

What is the utility of the break-even point?

Knowing the equilibrium point of a company allows us to know the level or volume of sales where the income is equal to the costs and thus, for example:

  • know how much we have to sell to cover our costs (how much do we have to sell to reach breakeven).
  • know how much we have to sell to start generating profits (how much do we have to sell to break even).
  • control our costs (by ensuring that they do not exceed the breakeven point).
  • have a basis on which to plan our sales and the profits we want to have (once we know what the break-even point is, it is easier to plan how much we want to sell or earn).
  • have a basis on which to set the prices of our products or services (once we know what the balance is, it is easier to determine our prices).

Generally, the equilibrium point of a company is calculated and analyzed; however, it is also possible to calculate and analyze the balance point of other elements of it such as:

  • an area or department : for example, to know how much it must generate in income to overcome its costs, and thus begin to be profitable.
  • a certain product : for example, to know how many we have to sell to overcome its costs, and thus start generating profits.
  • an investment project : for example, to know how much you must generate in income to recover your investment, and thus be considerably viable.
  • a customer : for example, to know how much they have to buy from us to overcome the costs they generate, and thus be considered profitable.

Likewise, the break-even point is generally calculated and analyzed when an investment is to be made (for example, in the creation of a company, the launch of a product, or a marketing campaign) in order to know how much is what it has to be sold to cover the investment.

How to calculate and analyze the breakeven point?

Here we present the steps necessary to calculate and subsequently analyze the equilibrium point of a company.

1. Determine costs

First, we must determine what disbursements we are going to consider as costs.

The usual thing when calculating the equilibrium point of a company is to consider all costs related to the product as costs ; that is, to all disbursements related to:

  • the acquisition of merchandise : in the case of a marketing company (for example, merchandise, transport, storage, etc.).
  • the production of the product : in the case of a production company (for example, the raw material, the fuel necessary for the operation of the machines and equipment, their maintenance, etc.).
  • the provision of the service : in the case of a service company (for example, the supplies needed to provide the service, the salaries of the workers dedicated to providing the service, etc.).

Including administration expenses (for example, managers and administrators salaries, rents, basic services, etc.), and sales expenses (for example, salesmen’s salaries, advertising, etc.); but not financial expenses (the payment of acquired debts) or taxes (total cost method of cost accounting ).

However, when it comes to a small business, it is advisable to consider all business disbursements, including financial expenses and taxes, as costs.

2. Classify costs into Variable Costs and Fixed Costs

Once we have determined what disbursements we are going to consider as costs, we proceed to classify these into Variable Costs (CV) and Fixed Costs (CF):

  • Variable Costs : variable costs are costs that vary (increase or decrease) based on changes in activity levels (the number of units sold in the case of a marketing company, the volume of production in the case of a company producer or the number of services provided in the case of a service company).

    Examples of variable costs are raw materials, fuels, spare parts, packaging, hourly wages, etc.

  • Fixed Costs : Fixed costs are costs that do not vary based on changes in activity levels but remain fixed. Examples of fixed costs are rents, machine and equipment maintenance, depreciation, insurance, fixed wages and salaries, etc.

3. Find Unit Variable Cost

Once we have divided the costs into Variable Costs and Fixed Costs, we proceed to find the Unit Variable Cost (CVU), which is obtained by dividing the Total Variable Costs by the number of units sold (Q).

4. Apply break-even formula

Once we have obtained the Unit Variable Cost, we proceed to apply the formula to find the equilibrium point, which is the following:

Pe = CF / (PVU – CVU)

Where:

  • Eg : break-even point (units to be sold in such a way that the income equals the costs).
  • CF : fixed costs.
  • PVU : unit sale price.
  • CVU : unit variable cost.

The result obtained through this formula will be in physical units. If we want to find the equilibrium point in monetary units, we simply must multiply the result by the sale price.

5. Check results

Once we have calculated the break-even point, we proceed to check the result through the preparation of an income statement , where we must ensure that the profits are equal to 0.

6. Analyze breakeven point

Finally, once we have calculated the equilibrium point and verified the result through the elaboration of an income statement, we proceed to analyze it; for example, to know how much we need to sell to cover our costs, or how much we must sell to start generating profits.

Example of how to calculate and analyze the breakeven point

Let’s see below an example of how to calculate and subsequently analyze the break-even point of a company following the steps we have previously described.

A company dedicated to the marketing (buying and selling) of shirts sells shirts at a price of US $ 40, the cost of each shirt is US $ 24, a sales commission of US $ 2 is paid, and its fixed expenses (rent, wages , basic services, etc.) amount to US $ 3,500.

What is the break-even point in sales units and in monetary units?

Finding the equilibrium point:

PVU = 40

In the event that a product has several sales prices, to determine the unit sale price we must find an average unit sale price .

CVU: 24 + 2 = 26

CF = 3500

Applying the equilibrium point formula:

Pe = CF / (PVU – CVU)

Pe = 3500 / (40 – 26)

Pe = 250 units.

Pe in monetary units: 250 x 40 = US $ 10,000

Checking:

Sales (PVU x Q): 40 x 250 10000
(-) CV (CVU x Q): 26 x 250 6500
(-) CF 3,500
Net profit 0

Analyzing the equilibrium point obtained we can obtain the following conclusions:

  • the break-even point is 250 units, which means that you need to sell 250 shirts so that the income is equal to the costs (there is no profit or loss), from the sale of 251 shirts you would only be starting to generate profits , and the sale of 249 shirts or less would mean losses.
  • the break-even point in currency units is $ 10,000, which means that you need to sell $ 10,000 in shirts for income to equal costs, sales greater than that amount would mean profit, and sales less than that amount would mean loss .
  • if, for example, 200 shirts had been sold, then 51 shirts would have to be sold to overcome the break-even point and, therefore, to start generating profits and the shirts are considered a profitable product.

As an additional note, when selling 250 shirts the income would equal the costs and, therefore, the profits would be US $ 0; But if, for example, 800 shirts were sold, then the profits would amount to US $ 7,700:

Sales (PVU x Q): 40 x 800 32000
(-) CV (CVU x Q): 26 x 800 20800
(-) CF 3,500
Net profit 7700

Summary

The equilibrium point is the point of activity where the income is equal to the costs and, therefore, the point of activity where there is no profit or loss.

Knowing the equilibrium point of a company allows us to know the level or volume of sales where the income is equal to the costs and thus, for example, to know how much we have to sell to cover our costs or to start generating profits .

Generally, the equilibrium point of a company is calculated and analyzed; however, it is also possible to calculate and analyze the equilibrium point of other elements of it, such as a product or a customer; for example, to know how much they must generate in income to be considered profitable.

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