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Break Even Point: Avoiding Losses

by: sahil | last updated: May 25, 2010
Category: Small Business Savings | Tags: break-even point, BEP, profits, losses, cost accounting, cost volume profit analysis

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Break Even Point: Avoiding Losses

The break-even point for any company is when the costs or expenses are equal to the revenue that is earned. This means that any revenue that comes in after the break-even point is the profit or any shortcoming is the loss. Simply put the break-even point is the number of units that need to be produced in order to earn profits and stay afloat. This is an important parameter in small businesses as the amount of production is comparatively small and the relation between productivity and profits is fragile and sensitive.

The three variables that are used in computing the break-even point are the price of the product, the fixed costs, and variable costs. An example of fixed costs would be overheads that more or less remain unchanged and variable costs are those that constantly change such as the cost of the goods that are sold. Variable costs generally tend to change according to the change in the level of sales which may not be the case with fixed costs. The calculation of break-even point is necessary since managers and self employed or small businesses can avoid loss by cutting the variable costs or by curtailing the fixed costs or by simply increasing the price of the finished product.

The break-even point is one of the simplest ways to determine the profits and is one of the least used. The computation not only provides a dynamic and latest view of the relation between costs and profits but it may also help in cutting unnecessary costs. The mathematical formula for calculating the break-even is simply the fixed costs divided by the difference between the price and the variable costs. The denominator; i.e. the price and variable costs are expressed per unit.

In an economy that has seen recent turmoil and upheaval it becomes important to know the amount of production required to achieve the break-even point. Also, management can make decisions about cutbacks in the form of lay offs or reduced salaries in order to keep the company from incurring a loss. For example if the price of each unit is $1 and the variable cost is $0.40 with fixed costs of $60,000 then the break-even would be 100,000 units. Now if in recession, sales drop then by reducing the fixed costs the break-even can be achieved. For instance, if the fixed costs are reduced to $50,000 then the number of units required would be 83,333 units instead of 100,000 units.

The break-even point is one of the underrated but a wise measure of a company’s success and along with an acid test or P&L statement/balance sheet can be a powerful tool to calculate the profits and the targets required for achieving these profits. Moreover, it does not require too many mathematical or even financial skills to do the number crunching, making it a hassle free and easy method of judging the relations between the various parameters in a business entity; especially small business ventures.