What Is Break-Even Point? (BEP) Calculating the break-even point requires the calculation of a margin of safety comparing revenues associated costs. This analysis is essential to determine what level of sales are necessary to cover the company's total fixed costs.
Break-even point tells you at what level sales is required to cover costs of product and overheads incurred.
Think of it as a margin of safety preventing making a loss.
How Break-Even Point Works Break-even is useful in the determination of the level of production or a targeted desired sales mix. BEP is use for management. This type of analysis depends on 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 of a product per individual unit less the variable costs of production. Fixed costs are those which remain the same regardless of how many units are sold. Therefore Break Even Analysis is useful for understanding 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 do not exceed sales revenue. However, the accumulation of variable costs will limit the leverage of the company as these expenses come from each item sold. Contribution Margin The concept of break-even analysis deals with the contribution margin of a product. The contribution margin is the excess between the selling price of the product and total variable costs. For example, if an item sells for $100, the total fixed costs are $20 per unit, and the total variable costs are $40 per unit, the contribution margin of the product is $60 ($100 - $40). This $60 reflects the amount of revenue collected to cover the remaining fixed costs, excluded when figuring the contribution margin. Calculations For BEP The calculation of break-even analysis may use two equations. In the first calculation, divide the total fixed costs by the unit contribution margin. In the example above, assume the value of the entire fixed costs is $18,000. With a contribution margin of $60, the break-even point is 300 units ($18,000 divided by $60). Upon the sale of 300 units, the payment of all fixed costs are complete, and the company will report a net profit or loss of $0. Alternatively, the calculation for a break-even point in sales dollars happens by dividing the total fixed costs by the contribution margin ratio. The contribution margin ratio is the contribution margin per unit divided by the sale price. Returning to the example above the contribution margin ratio is 60% ($60 contribution margin per item divided by $100 sale price per item). Therefore, the break-even point in sales dollars is $30,000 ($18,000 total fixed costs divided by 60%). Confirm this figure by multiplying the break-even in units (300) by the sale price ($100) which equals $30,000.