Break Even Analysis: Ultimate Guide to Understanding Breakeven Point

The breakeven point for a company is the number that a company must surpass to make a profit. It is that position when, after the sale of a company’s products or services, it neither earns any profit nor goes through loss.

Knowing the Breakeven point is important because it tells us how much revenue (sales) your business has to generate to cover expenses.  Anything above this amount provides us with extra cash to reinvest in your business and/or pay our own salary.

Break-Even Analysis is a process that helps a company analyze how profits change as revenue fluctuates. It explores the relationship between expenses and revenues. Revenues are the amount you earn for selling our product and expenses are the operating and production costs.

Different Types of Expenses Used in Breakeven Calculation

Variable Expenses

Variable expenses are those expenses that are directly associated with the product or service. These are the costs that are incurred on the product during its creation and distribution. These expenses are tied up to revenues. Revenues go up, variable expenses go up; revenues go down, and variable expenses go down. For example, Materials used to make the product, sales tax, shipping charges, product waste disposal, etc are all variable expenses. These keep on changing according to the quality of the product being created and the market also.

Fixed Expenses

These remain constant whether revenues rise or fall. They HAVE TO BE incurred, whether the company is earning a profit or going through a loss. Building rent, Salary and Wages, Depreciation & other utilities are examples of fixed expenses.

Mixed Expense

These are part variable and part fixed. Sales Commission for example is a variable expense but is added to Labor costs which are fixed expenses. These expenses are separated and placed with their appropriate type of expenses. Variable portion with variable expenses and fixed portion with fixed expenses.

Contribution Margin Equation

The contribution margin is the amount of money left over from selling one unit of the product after the total variable expenses of production are covered. The Contribution Margin of one product unit is:

Revenue/Unit - Variable expenses/Unit

Example:

Materials = ₹10

Sales Commission = ₹7

Shipping = ₹3 

Total Variable Expenses = ₹20

Now if each of the products is sold for ₹100 then,

Contribution Margin => ₹100 - ₹20 = ₹80

It tells us that the variable expenses of  ₹20 per unit are covered and we have ₹80 per unit to contribute to fixed assets.

Brean Even Point Equation

As we have already discussed what Break-Even Point is. Here we will discuss how to calculate it using the following equation:

BEP (Units/day) = (Fixed expenses per day) / (Contribution Margin per unit) 

Equation I 

 Let’s take the previous example in which we had a product of the following specification:

• Variable expenses: ₹20
• Selling Prices: ₹100
• Contribution margin: ₹80

Assuming fixed expense as follows:

• Rent                            ₹100
• Utilities                       ₹70
• Hourly Wages             ₹200
• Depreciation               ₹110
• Total fixed expenses   ₹480

Now we have the data, we need to find how many units would have to be sold per day to meet the fixed expenses,

From Equation I,

BEP = ₹480 / ₹80 = 6 Units

That implies that we must sell at least 6 units per day to cover all the expenses (variable plus fixed). ONLY TO COVER EXPENSES.

This point is the Breakeven Point. Every unit that the business sells beyond 6 per day will make up a profit.

Graphical Representation of Breakeven Point

• TR          – Total Revenue
• TFC        – Total Fixed Cost
• TC          – Total (Variable) Cost
• BEP        – Break-even point