A company is less likely to earn profits at the beginning of the business due to higher initial investment. You first have to reach a point where you neither see loss nor profit. Once you reach this neutral point, you can start earning profit gradually. This point is known as the break-even point, where total earnings equal total expenses. Let’s understand what the break-even point is and how to calculate the break-even point.
A break-even point is a specific level where the total revenue is equal to the total cost. At this point, you neither have losses nor profits.
This point is achieved by selling a specific number of product units. Once you exceed this point, you will earn profit. The more you surpass this point, the more you earn profit.
Simply put, the higher the sales units after the break-even point, the higher the total profit. However, you must also consider both fixed and variable costs.
Fixed Cost/(Selling Price Per Unit - Variable Cost Per Unit) = Break-Even Point
Fixed costs are the unchanged expenses you must bear regardless of the product units you sell. They don’t increase or decrease from business activities.
Variable costs are the expenses that change depending on the number of product units you sell. The more product units you sell, the higher the variable costs.
For example, you sell a product. The fixed costs are $100,000. Their per-unit variable costs are $50. The sales price per unit is $100.
Break-Even Point = 100,000/ (100-50) = 100,000/50 = 2000 units
Hence, you must sell a minimum of 2,000 units to reach the break-even point.
The following are the key factors that affect the break-even point.
A company must pay some unavoidable expenses, such as office rent and employees’ salaries. Fixed costs determine the number of units you must sell to reach the break-even point. But you can’t increase or decrease the total fixed expenses regardless of the units you sell.
Some expenses change as you sell more product units. Common variable costs are raw materials, labor costs, utilities, commissions, etc. Selling more units helps you reduce the total variable costs and achieve the break-even point.
Selling Price Per Unit
If you increase the selling price per unit, you will have to sell fewer units. The break-even point decreases as the selling price per unit increases. On the other hand, you need to sell more units to break even if you cut the selling price per unit.
The break-even point can be significantly impacted by market competition and product demand. It has an immediate effect on how many units a business can sell and how much they can charge.
Understanding and analysing the break-even point helps a company to estimate the number of units it must sell to earn its specific level of profit. You can calculate how much you must deduct from the profit, including both fixed and variable costs.
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