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What is Break-Even Point?
A Break-Even Point in business is a point where a company’s total investment and total revenue are equal, i.e. the company has recovered all its investment, but is yet to make any profit.
In terms of sales, a Break-Even Point occurs when the total cost of production equals the total income generated from sales. For example, if you produced 10000 headphones at a production cost of $8 per headphone, your break-even point would occur when you would have generated $80000 in sales. The fixed costs for the headphones are not taken into account in this case, but they should also be considered while conducting a break-even analysis.
What is Break-Even Analysis?
Break-Even Analysis is the process of determining the break-even point for a product taking into account several other factors as well.
In addition to the production costs, you must also consider fixed costs as well during a break-even analysis. Fixed costs are costs that do not change irrespective of your production or your sales amount, such as rent, salaries, etc. These can be a very significant amount, thus we need to consider them while doing any analysis.
Let us continue with the above example, in addition to the production cost or variable costs, since they vary with the proportion of goods manufactured of the headphones, you spent $20000 on marketing, spent $15000 on salaries, and other expenses of $25000. The total costs come to a total of $140000 at the end of the first month. In the second month, these expenses rise to $155000 and so on.
Now, let’s say, you decide to sell a single headphone at $25. At the end of the first month, your company would be required to sell 5600 (=140000/25) headphones to break even.
Importance of Break-Even Point
A break-even point gives a clear idea about the sales required for a company to start generating profits from a product. Analyzing the break-even point also helps determine the magnitude of risks involved and whether the product could sustain in the market with that amount of risk involved.
Break-even analysis is also essential for a company planning an expansion to a new territory or entering new markets.
Break-even analysis helps a company design its pricing strategy around a product. If they feel that the number of units required to be sold to break even is high enough, they could increase the selling price of the product a bit to bring that number down.
By performing a break-even analysis, the company knows well in advance the amount of sales where they would break even. Thus, it becomes easier for them to set a feasible goal and budget accordingly. This decreases the waste of resources and also helps the team know their exact target from the start.
A company could explore multiple paths regarding the development and the launch of its products. Performing a break-even analysis for every path could help the company determine which of the paths would be the most profitable given the current market sentiments.
Q: What is the formula for calculating the break-even point?
A: The formula for calculating break-even point:
Break-even point = Fixed costs / (Selling price per unit – Variable costs per unit)
Suppose if the fixed costs for a product are $10000 and the selling price per unit is 12$ and variable costs per unit are $2, then the break-even point will be 10000/(12-2) = 1000 units.
Q: What is the difference between break-even and shutdown point?
A: The break-even point is the point at which the company’s revenue equals its cost incurred on a product. The shutdown point, on the other hand, is the lowest price a company can maintain for a product to justify continuing its production.