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Break-even point is a money term you need to understand. Here’s what it means.
What is the break-even point?
In business accounting, the break-even point refers to the amount of revenue necessary to cover the total fixed and variable expenses incurred by a company within a specified time period. This revenue could be stated in monetary terms, as the number of units sold or as hours of services provided.
The break-even point also can be considered as the point in time when revenue forecasts are exactly equal to the estimated total costs. This is where a company’s losses end and its profits start to accumulate. At this point, a project, product or business is financially viable.
Although it does not seem like much of a business goal, breaking even is an important point of reference for finance professionals. A company or project’s break-even point gives a valuable benchmark that helps to develop long-term business plans. Knowing your break-even points for key areas like sales, investment repayments, production and operations helps you determine pricing of products, debt servicing and other operational aspects of your business. If you know your break-even points, it’s easy to see the effect of different business strategies.
Potential investors in a business not only want to know the return to expect on their investments but also the point when they will realize this return. This is because some companies may take years before turning a profit, often losing money in the first few months or years before breaking even. For this reason, break-even points are an important part of any business plan presented to a potential investor.
Break-even point example
ABC Company calculates that its fixed costs consist of executives’ salaries, depreciation of its assets, property taxes and its lease. The company’s fixed costs of production of its main product, the widget, adds up to $60,000. There are also variable costs involved in the production of the widget, including factory labor, raw materials and sales commissions. The company calculates that these variable costs add up to 80 cents per widget. Each unit is sold at $2.
With this information at hand, it is possible to calculate the break-even point for production and sale of ABC Company’s widget by using the formula below:
$60,000 / ($2 – $0.80) = 50,000 units
The figure calculated above simply means that ABC Company has to manufacture and sell 50,000 of its widgets to cover all their fixed and variable expenses. By making this number of sales, the company makes no profit. It just breaks even.
If you’re making an investment, use this calculator to figure out your earnings.
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