Break-even point analysis

Explanation of break-even point:

The point at which total of fixed and variable costs of a business becomes equal to its total revenue is known as break-even point (BEP). At this point, a business neither earns any profit nor suffers any loss. Break-even point is therefore also known  as no-profit, no-loss point or zero profit point. Calculation of break-even point is important for every business because it tells business owners and managers how much sales are needed to cover all fixed as well as variable expenses of the business or the sales volume after which the business will start generating profit. The computation of sales volume required to break-even is known as break-even analysis. The concept explained above can also be presented as follows:

break-even-point-concept

After reading this article you will be able to compute the break-even point of a single product company using two popular methods – equation method and contribution margin method. First we shall compute break-even point using these two methods and then present the information graphically (preparation of break-even chart).

Computation of break-even point:

(1). Use of equation method:

The application of equation method facilitates the computation of break-even point both in units and in dollars. As we have already described that the sales are equal to total variable and fixed expenses at break-even point, the equation can therefore be written as follows:

Sp × Q = Ve × Q + Fe

Or

SpQ = VeQ + Fe

Where;

Sp = Sales price per unit.

Q = Number (quantity) of units to be manufactured and sold during the period.

Ve = Variable expenses to manufacture and sell a single unit of product.

Fe = Total fixed expenses for the period.

Notice that the left hand side of the equation represents the total sales in dollars and the right hand side of the equation represents the total cost. If the information about sales price per unit, variable expenses per unit and the total fixed expenses is available, we can solve the equation for ‘Q’ to find the number of units to break-even. The break-even point in units can then be multiplied by the sales price per unit to calculate the break-even point in dollars. Suppose, for example, you run a manufacturing business that is involved in manufacturing and selling a single product. The annual fixed expenses to run the business are $15,000 and variable expenses are $7.50 per unit. The sale price of your product is $15 per unit. The number of units to be sold to break even can be easily calculated using equation method:

Sp × Q = Ve × Q + Fe

15 × Q = 7.5 × Q + 15,000

15 Q = 7.5 Q + 15,000

15Q – 7.5Q = 15,000

7.5Q = 15,000

Q = 15,000 / 7.5

Q = 2,000 units

The break-even point in units is 2,000 units and the break-even point in dollars can be computed as follows:

= (2,000 units) × ($15)

= $30,000

(2). Use of contribution margin method:

The method described above is known as equation method of calculating break-even point. Some people use another method called contribution margin method (read about contribution margin and its calculation). Under this method, the total fixed expenses are divided by contribution margin per unit. Consider the following computations:

Total fixed expenses / Contribution margin per unit

= 15,000 / 7.5*

= 2,000 units

or

= (2,000 units) × ($15)

= $30,000

*$15 – $7.5

A little variation of this method is to divide the total fixed expenses by the contribution margin ratio (CM ratio). Doing so results in break-even point in dollars. It is shown below:

Total fixed expenses / Contribution margin ratio

= $15,000 / 0.5*

= $30,000

*($15 – $7.5)/$15

Graphical presentation (Preparation of break-even chart or CVP graph):

The graphical presentation of dollar and unit sales needed to break-even is known as break-even chart  or CVP graph:

break-even-chart-or-cvp-graph

Explanation of the graph:

  1. The number of units have been presented on the X-axis (horizontally) where as dollars have been presented on Y-axis (vertically).
  2. The straight line in red color represents the total annual fixed expenses of $15,000.
  3. The blue line represents the total expenses. Notice that the line has a positive or upward slop that indicates the effect of increasing variable expenses with the increase in production.
  4. The green line with positive or upward slop indicates that every unit sold increases the total sales revenue.
  5. The total revenue line and the total expenses line cross each other. The point at which they cross each other is the break-even point. Notice that the total expenses line is above the total revenue line before the point of intersection and below after the point of intersection. It tells us that the business suffers a loss before the point of intersection and makes a profit after this point.  The break-even point in the above graph is 2,000 units or $30,000 that agrees with the break-even point computed using equation and contribution margin methods above.
  6. The difference between the total expenses line and the total revenue line before the point of intersection (BE point) is the loss area. The loss area has been filled with pink color. Notice that this area reduces as the number of units sold increases. It means every additional unit sold before the break-even point reduces the loss.
  7. The difference between the total expenses line and the total revenue line after the point of intersection (BE point) is the profit area. The profit area has been filled with green color. Notice that this area increases as the number of units sold increases. It means every additional unit sold after the break-even point increases the profit of the business.

 

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31 Comments on Break-even point analysis

  1. Anny

    Good explanation of the basic concept through text, formula, equation and graphical presentation. Thank you for the great work.

    Anny

  2. David

    Can I use these formulas and equations to calculate the break-even point if a company produces more than one product?

  3. Gladys

    I want to find out some additional information.

  4. Rahul verma

    thanks for a brief explantion…

  5. Rahul verma

    Thank you.. becoz I really understand..the concept break even point..

  6. Ifrah

    I really understand this formula Thanks

  7. esther minyoi

    it was very helpful and i understand the formula fully

  8. muhammad fawad

    thanks really help me out during papers/. wo b paper sy 20 min pehly 🙂

  9. Daniel

    please can you explain break even as a technique of control in an organisation..?

  10. ikenna

    the effect of break even to a close down company

  11. cyber Shah

    hellow!
    m still a student of logistics management. i have exams tomorrow infact my final exams. am very nervous but i hope it works out. thanks much!

  12. mukul

    Very well explained.. but how did you sketched the total expenses curve as it is a slope

  13. machuki morwani

    I HAVE REALLY UNDERSTOOD THE CONCEPT

  14. seyiliberal

    Just got what I actually needed on BEP for on a single product

  15. Serazul Imam

    Very explanatory for understanding

  16. riaz ul haq

    Thanks for giving idea.

  17. sintayehu

    Thanks a lot

  18. NegoKing

    I’m so grateful for this timely info. I have learnt a great deal! Thanks a MILLION

  19. Muhumuza Moses

    this is a wonderful work from you, big ups
    I now understand the mathematical equation and the contribution margin methods

  20. WEJULI MATHIAS

    so educative thankx

  21. Noel Rop

    sir where exactly will we insert the break even point in the business and , is the break even relate to the budget?

  22. Sriganesh

    what are the costs are variable and fixed in this regard plz

  23. hiwot menkir

    can you help me?

  24. emcee

    best expanation in all im satisfied and my task is answered by you full mark.👍
    thanks very huge.

  25. Kiprotich sam

    Nice work but u need to sent to my gmail account

  26. S.Kaluarachchi

    Very nice explanation. It can easily understand.Thank you.

  27. Samson

    Assuming a Manufacturer sets out to produce 6000 units, given a variable cost of #40 per unit and a fixed cost of#60,000, what’s the unit cost?

    Also, if the selling price is 20℅ over and above the unit cost, what would be the selling price and the overall profit at the 6000 unit production level?

  28. sonia

    this was helpful

  29. Ogunsan Esther

    thanks for clear explanation

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