The break-even point can be defined as a point where total costs (expenses) and total sales (revenue) are equal. In other words, it can be described as a point where there is no net profit or loss. It serves as an important tool for long term planning for any business.
Break even point helps in decision making in areas such as deciding prices, setting sales budgets, and preparing business and operations plans.
DETERMINATION OF BREAK EVEN POINT
In accounting, the breakeven point formula is determined by dividing the total fixed costs associated with production by the revenue per individual unit minus the variable costs per unit.
Fixed costs are expenses that remain the same, regardless of how many sales are made. On the other hand, variable costs change based on the sales activity. With an increase in sales, the variable costs also increase . Examples of variable costs include direct materials and direct labor.
FORMULA :- The following formula is used to calculate the Break even point –
Break-even Point Per Unit = Fixed Costs / (Sales Price Per Unit – Variable Costs Per Unit)
It must be remembered that fixed costs are the overall costs, and the sales price and variable costs are just per unit.
IMPORTANCE OF BREAK EVEN ANALYSIS
Break-even point is a key financial analysis tool that is commonly used by many business owners. It is useful for the following reasons –
- It helps to determine the impact on profit on changing to automation from manual (a fixed cost replaces a variable cost).
- It helps to determine the amount of losses that could be sustained if there is a sales downturn.
- With break-even charts, managers can determine the impact of changing selling prices on sales volume and profitability.
- The break even point analysis motivates the sales staff as it helps the sales employees to see the results of extra sales on profits and the potential for more commissions.
Thus, in simple words Break-even point implies the level of business at which the firm’s total income equals total expenditure and helps in determining the profit planning of the business.