BREAK-EVEN POINT
A company's break-even point is the amount of sales or revenues that it must generate in order to equal its expenses. In other words, it is the point at which the company neither makes a profit nor suffers a loss. Calculating the break-even point (through break-even analysis) can provide a simple, yet powerful quantitative tool for managers. In its simplest form, break-even analysis provides insight into whether or not revenue from a product or service has the ability to cover the relevant costs of production of that product or service. Managers can use this information in making a wide range of business decisions, including setting prices, preparing competitive bids, and applying for loans.
BACKGROUND
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It is particularly interesting to note that the higher the fixed costs, the higher the break-even point. Thus, companies with large investments in equipment and/or high administrative-line ratios may require greater sales to break even.
As an example, if fixed costs are $100, price per unit is $10, and variable costs per unit are $6, then the break-even quantity is 25 ($100 ÷ [$10 − $6] = $100 ÷$4). When 25 units are produced and sold, each of these units will not only have covered its own marginal (variable) costs, but will have also have contributed enough in total to have covered all associated fixed costs. Beyond these 25 units, all fixed costs have been paid, and each unit contributes to profits by the excess of price over variable costs, or the contribution margin. If demand is estimated to be at least 25 units, then the company will not experience a loss. Profits will grow with each unit demanded above this 25-unit break-even level.
While it is useful to know the quantity of sales at which a product will cease to generate losses, it may be even more useful to know the quantity necessary to generate a desired level of profit, say D.
TR − TC = D
P× Q − (F + V× Q) = D
Then Q = (F + D) ÷ (P − V)
This has the effect of regarding the desired profit as an increase in the fixed costs to be covered by sales of the product. As the
Total contribution needed to cover the old fixed costs + new fixed cost + profit is just the three factors added together.
d) Break even sales change that would change the profits by the same amount as a reduction in price.
Although the financial goal is to create profit, we need to calculate the breakeven point to get started.
5. Determine the necessary sales in unit and dollars to break-even or attain desired profit using the break-even formula.
Determine the unit break-even point, assuming fixed costs are $60,000 per period, variable costs are $16.00 per unit, and the sales price is $25.00 per unit.
Because each product has a different contribution margin percentage, the volume required for each break-even point would be different and will not add up to the company’s overall break-even volume of 1,100,000 units; the overall break-even volume assumes that there is only one contribution margin percentage which is :
Fixed costs in 2004 are lower that of 2003 and contribution margin ratio is higher in 2004 than that of 2003. Hence, the break even point is lower for 2004.
Although, break-even is very helpful for a company to see where they are and how much improvement they can make, the company can never say that it is 100% correct as change in costs or selling price can affect this analysis greatly. Also, in the short-run break-even analysis can show an accurate figure where as in a long run, it will be a lot more difficult. So, break-even analysis is not that accurate.
The $320,000, on the other hand, is a fixed cost associated with the proposed addition.
This question gives students an opportunity to exercise their ability to interpret break-even analyses. Key teaching points should include explaining the preparation of a break-even chart, the interpretation of the break-even volume (938,799 hectoliters [HL]), and the comparison of the break-even volume to the current volume (1,173,000 HL). Another key point is that the chart in case Exhibit 5 is relevant only for the current cost structure of the company—if variable costs increase or the plant expansion is approved, the break-even volume will rise. Finally, students should be aided in understanding that “break-even” refers to operating profit, not free cash flow. The typical use of the break-even chart ignores taxes, investments, and the depreciation tax shield.
Break-even point analysis is a measurement system that calculates the margin of safety by comparing the amount of revenues or units that must be sold to cover fixed and variable costs associated with making the sales. In other words, it’s a way to calculate when a project will be profitable by equating its total revenues with its total expenses. There are several different uses for the equation, but all of them deal with managerial accounting and cost management (Break-Even Point, n.d.)
Break even analysis can be used to decide whether to alter the existing product emphasis or not. For example in this case, if we refer last year’s data, we can see that the product C is not economically feasible to manufacture at $2.40 / unit. Following table gives the analysis for checking whether the company can afford to invest in additional “C” capacity.
Breakeven = fixed cost/margin = total dollar fixed costs/ unit selling price –unit variable costs
While cost is seldom the only criterion used in a make-or-buy decision, simple break-even analysis can be an effective way to quickly surmise the
This affects the decrease of net income and requires increased revenue of sales in order to restore profit.