Break-Even Analysis: Definition and Formula
For example, a business that sells tables needs to make annual sales of 200 tables to break-even. At present the company is selling fewer than 200 tables and is therefore operating at a loss. As a business, they must consider increasing the number of tables they sell annually in order to make enough money to pay fixed and variable costs. The break-even point (BEP) in economics, business—and specifically cost accounting—is the point at which total cost and total revenue are equal, i.e. “even”.
- You would not be able to calculate the break-even quantity of units unless you have revenue and variable cost per unit.
- An unprofitable business eventually runs out of cash on hand, and its operations can no longer be sustained (e.g., compensating employees, purchasing inventory, paying office rent on time).
- Investors should consider calculating a potential investment’s break-even point before committing capital to something with a high initial cost, such as a large commission or other expense.
- This influences which products we write about and where and how the product appears on a page.
At this point, the total costs are just as high as the total revenue, meaning that the company is making neither a profit nor a loss. Fixed costs are costs incurred during a specific period of time that do not change with the increase or decrease in production or services. Once established, fixed costs do not change over the life of an agreement or cost schedule. For this calculator, we are calculating the fixed costs on a monthly basis.
Variable costs can also be degressive, meaning that they increase less sharply than the turnover. That can be the case, for example, when you receive volume discounts due to larger purchase volumes. The break-even calculations are based on the assumption that the change in a company’s variable costs are related to the change in revenues. This assumption may not hold true for a variety of reasons including changes in the mix of products sold and varying contribution margins of the products. In accounting, the break-even point refers to the revenues necessary to cover a company’s total amount of fixed and variable expenses during a specified period of time. The revenues could be stated in dollars (or other currencies), in units, hours of services provided, etc.
Overall, break-even analysis is a critical tool in the financial world for businesses, stock and option traders, investors, financial analysts and even government agencies. In this breakeven point example, the company must generate $2.7 million in revenue to cover its fixed and variable costs. Break-even analysis looks at the level of fixed costs relative to the profit earned by each additional unit produced and sold. In general, a company with lower fixed costs will have a lower break-even point of sale. For example, a company with $0 of fixed costs will automatically have broken even upon the sale of the first product assuming variable costs do not exceed sales revenue.
Calculating the break-even analysis is useful in determining the level of production or a targeted desired sales mix. The study is for a company’s management use only, as the metric and calculations are not used by external parties, such as investors, regulators, or financial institutions. This type of analysis involves a calculation of the break-even point (BEP). The break-even point is calculated by dividing the total fixed costs of production by the price per individual unit, less the variable costs of production. Fixed costs are costs that remain the same regardless of how many units are sold.
Benefits of a Breakeven Analysis
The contribution margin is easy to calculate, provided that you have an overview of your company’s cost structure. Pay close attention to product margins, and push sales of the highest-margin items, to reduce the breakeven point. Our partners cannot pay us to guarantee favorable reviews of their products or services. We believe everyone should be able to make financial decisions with confidence. From this analysis, you can see that if you can reduce the cost variables, you can lower your breakeven point without having to raise your price. As we can see from the sensitivity table, the company operates at a loss until it begins to sell products in quantities in excess of 5k.
The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Knowing an investment’s break-even point can help you make better-informed investment decisions. It will show the threshold needed to reach so that an investment doesn’t lose money.
- Also, break-even analysis ignores external factors such as competition, market demand, and changing consumer preferences, which can have a significant impact on a businesses’ top line.
- Pay close attention to product margins, and push sales of the highest-margin items, to reduce the breakeven point.
- Consider the following example in which an investor pays a $10 premium for a stock call option, and the strike price is $100.
- As we can see from the sensitivity table, the company operates at a loss until it begins to sell products in quantities in excess of 5k.
Likewise, a real estate investment could have high upfront costs from commissions and renovations that an investor would need to overcome before reaching profitability. After calculating the break-even cost, an investor might determine that the investment isn’t worthwhile since it might take too long or too much effort to get the BEP. If you want to determine the BeP for a single product, it will be specified as a quantity of items (single-product analysis). The BeP for several products or for an entire company will be specified, in contrast, as the amount of turnover that must be earned in total (multi-product analysis). This gives you the number of units you need to sell to cover your costs per month. If sales drop, then you may risk not selling enough to meet your breakeven point.
Understanding Breakeven Points (BEPs)
The information required to calculate a business’s BEP can be found in its financial statements. The first pieces of information required are the fixed costs and the gross margin percentage. Assume an investor pays a $4 premium for a Meta (formerly Facebook) put option with a $180 strike price. That allows the put buyer to sell 100 shares of Meta stock (META) at $180 per share until the option’s expiration date. If the stock is trading above that price, then the benefit of the option has not exceeded its cost. Homeowners and real estate investors can also use a break-even point to determine the price they’d need to achieve so they don’t lose money on a property sale.
How to Calculate Break-Even Point?
It is only possible for a firm to pass the break-even point if the dollar value of sales is higher than the variable cost per unit. This means that the selling price of the goods must be higher than what the company paid for the good or its components for them to cover the initial price they paid (variable and fixed costs). Once they surpass the break-even price, the company can start making a profit. Revenue represents total income generated from the sale of goods or services by an individual or business. The contribution margin is the difference between revenue and variable costs. The final component of break-even analysis, the break-even point, is the level of sales where total revenue equals total costs.
Factors that Increase a Company’s Break-Even Point
It also is a rough indicator of the earnings impact of a marketing activity. A firm can analyze ideal output levels to be knowledgeable on the amount of sales and revenue that would meet and surpass the break-even point. If a business doesn’t meet this level, it often becomes difficult to continue operation.
Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, administrative costs, withholding taxes and different accounting and reporting standards. They may have other tax implications, and may not provide the same, or any, regulatory protection. Exchange rate charges may adversely affect the value of shares in sterling terms, and you could lose money in sterling even if the stock price rises in the currency of origin. Any performance statistics that do not adjust for exchange rate changes are likely to result in an inaccurate portrayal of real returns for sterling-based investors. Here’s an example of figuring out the break-even point on a real estate investment. Meanwhile, they spent £15,000 on repairs, homeowners insurance, and other expenses during their ownership.
For existing businesses, this can be a useful tool not only in analyzing costs and evaluating profits they’ll earn at different sales volumes, but also to prove their potential turnaround after disaster scenarios. Either option can reduce the break-even point so the business need not sell as many tables as before, and could still pay fixed costs. You would not be able to calculate the break-even quantity of units unless you have revenue and variable cost per minimum requirements for working as an independent contractor unit. Calculating breakeven points can be used when talking about a business or with traders in the market when they consider recouping losses or some initial outlay. Options traders also use the technique to figure out what price level the underlying price must be for a trade so that it expires in the money. A breakeven point calculation is often done by also including the costs of any fees, commissions, taxes, and in some cases, the effects of inflation.