Break Even Point

Break-even Analysis

Break-even point is the determination of the total units that must be sold, or dollars that must be generated, before the firm covers all its operating costs, or before it breaks even. This is the point where the firm is neither earning a profit nor incurring a loss.

A little explanation as to what is needed to figure out the break-even point. There are three distinct variables that must be determined; all fixed costs, variable costs, and the selling price of products or services.

Fixed costs are all the costs which are either direct raw materials used in the production of goods or services, direct labor needed to produce the goods or services, and all overhead expenses such as, insurance and depreciation.

Variable costs are those expenses that vary with the number of sales. Materials used in the production of goods are the most obvious example of a variable cost. As the number of units sold increases the amount spent on materials increases. For this reason, variable expenses are dependent on the number of units sold.

Selling price of the goods or services is the last variable we must determine. As we spoke about earlier in the Marketing analysis, the price of a good or service must be consistent with the marketing objectives and pricing strategy. The selling price is the retail, wholesale, or distributor price we are willing to exchange our good or service for.

 The break-even formula is: Break-even point (BEP) = (Fixed Costs) / (Selling price-Variable Costs).

At this time we will throw out one more term, Contribution Margin (CM). The contribution margin is the difference between the selling price and variable costs. As we mentioned, variable costs vary with the number of units sold. Example: Selling price of \$10.00, Variable Costs of \$6.00. Contribution Margin (CM) = \$10 - 6 or \$4. In this example, \$4 is available to contribute towards the fixed costs. So for every \$10 sale the company covers \$6 in variable costs and has \$4 remaining to pay for overhead, depreciation, salaries, etc..

Let's take the example of a manufacturer who will make pens. They have determined fixed costs to be \$1,000. From our previous data we know the selling price of each pen is \$10 with variable costs of \$6. Knowing this information we can determine our Break-even point (BEP).

 \$1,000 / (\$10 - \$6) \$1,000 / (\$4) 250 pens = Break-even point

In this example the pen manufacturer must sell 250 pens to cover all fixed and variable costs. At this point the manufacturer is neither making a profit nor incurring a loss. After covering all fixed costs, each sale above 250 will contribute to profit.

The break-even analysis is a good tool when determining how many products must be sold before the firm begins to make money. The entrepreneur must be aware of long-term costs and sales volumes that may effect the break-even point. As costs increase the number of units that must be sold will also increase. Also, if sales forecasts are predicted to decline, then what will the break-even point be? These are issues that the entrepreneur must anticipate. more

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