break-even

Break-even is the point of balance in which the total cost and total income are equal. There is not a loss or gain due to the business has paid the cost and the profit is equal to 0. So is the minimum number of units that the company needs to sell to make a profit. It is shown graphically as the point where the total revenue and total cost curves meet.

Normally most companies worry about this topic and they ask themselves questions like this:
"At what level of sales will my company make a profit?"

The break-even point analysis will provide the answer to this question and some ideas about how gains change as sales increase or decrease.

Predicting an exact amount of sales or profits is nearly impossible because of the different factors which will complicate the break-even analysis. For example the many products and customers the companies usually have, and the interaction between price, promotion and the number of units sold.

The accounting method to calculate break-even point does not include cost of working capital. Another method to calculate this, is the financial method, called value added break-even analysis, which is used to evaluate the feasibility of a project. This method not only includes all costs, it also adds the opportunity costs of the capital needed to develop a project.

It is important to know that some expenses will increase while sales increase and decrease when sales decrease, these are called variable expenses such as raw material cost. Whereas other expenses will not change as sales increase or decrease, these are fixed expenses such as rent.

Also there are some expenses which are part variable and part fixed, these are called semi-variable expenses.  An example of that would be a salesperson's compensation that is composed of a salary portion (fixed expense) and a commission portion (variable expense).

If a company thinks that it cannot sell as many as it wants, to continue being profitable should do any of these actions to reduce the break-even point:
  • -Try to reduce the fixed costs
  • -Try to reduce variable costs
  • -Or increase the selling price of their products

The formula of break-even point is:

BEP= fixed expenses / (unit selling price – unit variable expense)

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