Contents
- What is the breakeven point?
- Why is the breakeven point important?
- How to calculate the breakeven point?
- Example of calculating the breakeven point
- Breakeven point graph
What is the breakeven point?
The breakeven point, also known as the threshold of profitability, is the volume of sales of goods or services at which a company's revenues cover all its costs. This means that all income generated from sales goes toward paying rent, salaries, purchasing raw materials, and other necessary expenses. Understanding this concept is critically important for any business, as it helps determine when the company starts to make a profit.
The breakeven point varies depending on the level of expenses, production volume, and income generated. The task of a professional entrepreneur is to surpass this threshold as quickly as possible, as failing to do so in a timely manner can lead to serious financial problems. It is important to remember that the breakeven point is not a static figure and can change based on fluctuations in costs and revenues.
Why is the breakeven point important?
Calculating the breakeven point is necessary for both the company's management and external experts looking to gain a deeper understanding of business processes. Internal analysts use the calculation methodology for the following purposes:
- Determining the minimum sales volume at which the company will start to make a profit;
- Optimizing the cost of goods at current prices;
- Justifying changes in pricing policy.
For investors and creditors, information about the breakeven point is an important criterion for assessing the stability of a business. The larger the gap from the breakeven point, the higher the financial stability of the enterprise. This indicator allows for evaluating the rate of development of the company and its solvency.
How to calculate the breakeven point?
To determine the moment the breakeven point is reached, two main formulas can be used. The first allows you to calculate the sales volume at which the company breaks even, and the second determines this figure in monetary terms:
- BEP (units) = TFC / (P - AVC)
- BEP (monetary) = BEP (units) * P
In these formulas, BEP (break-even point) corresponds to the breakeven point. The following data is required for the calculation:
- Fixed costs (TFC) — fixed expenses such as rent, salaries, utilities, and taxes.
- Variable costs per unit (AVC) — costs for raw materials and labor that change depending on the production volume.
- Sale price per unit (P) — the average price of the product if the company offers several products.
Example of calculating the breakeven point
Let's consider a factory producing shoes. The price of one pair of shoes is $20 (P). The monthly fixed costs (TFC) of the factory amount to $800, including rent, salaries, and utilities. The variable costs (AVC) associated with producing one pair of shoes are $15.
To calculate the breakeven point in units (in pairs of shoes), you need to divide the total fixed costs by the difference between the price and the variable costs:
BEP (units) = TFC / (P - AVC) = 800 / (20 - 15) = 160 pairs of shoes/month.
This means that the factory needs to sell 160 pairs of shoes to reach the breakeven point. The next step is to calculate this point in monetary terms:
BEP (monetary) = BEP (units) * P = 160 * 20 = $3200.
Thus, the factory will reach the breakeven threshold with a revenue of $3200.
Breakeven point graph
The breakeven point can be visualized using a graph. The vertical axis displays costs and revenues in monetary terms, while the horizontal axis shows the production or sales volume. The graph helps to determine the minimum sales or production volume necessary to cover all expenses and start making a profit.
Fixed costs are represented by a horizontal line, as they do not change with the volume of production. Variable costs and total costs can also be displayed on the graph to clearly see at what point the business starts to make a profit. The breakeven point graph is an important tool for entrepreneurs, allowing them to analyze their financial performance and make informed decisions to optimize business processes.