Break-even point (BEP) is a term in accounting that refers to the situation where a company’s revenues and expenses were equal within a specific accounting period. It means that there were no net profits or no net losses for the company – it “broke even”. BEP may also refer to the revenues that are needed to be reached in order to compensate for the expenses incurred during a specific period.
For example, Company ABC spent $100,000 on manufacturing costs and also acquired revenues worth $100,000. In such a case, the company only achieved its break-even point, which means it didn’t lose anything, but it didn’t earn anything either.
Accounting Break-even Point vs. Financial Break-even Point
There are several differences between the accounting break-even point and the financial break-even point.
Accounting break-even point, on the one hand, is the easiest and most common method of analyzing profits. It is easily calculated by taking the total expenses on a particular production and computing how many units of the product need to be sold in order to cover the expenses.
Financial break-even point, on the other hand, is more complicated to measure because it uses different measurements, even though it is the same concept. It doesn’t address a specific product or units number, but instead, a company’s earnings, specifically about how much it needs to earn in order that its earnings per share are equal to zero. Earnings mean the gross amount of money earned by the company before taxes and expenses are taken out.
What is Contribution Margin in Relation to Break-even Point?
The term contribution margin is often heard in relation to the break-even point. It refers to the actual profit a business can earn from every single unit sold. It is understood to be the product’s price, less the variable costs. Often, experts say the contribution margin shows the real profit and not the revenue.
How to Calculate for Break-even Point
There are two ways to compute for the break-even point – one is based on units and the other is based in dollars.
To compute for the break-even point in units, the following formula is followed:
Break-even Point (Units) = Fixed Costs / (Revenue Per Unit – Variable Cost Per Unit)
That’s the accounting break-even.
To compute for break-even point in dollars, the following formula is followed:
Break-even Point (Sales in dollars) = Fixed Costs / (Sales Price per Unit x BEP in Units
That’s the financial break-even.
Fixed Costs are the costs that are independent of the volume of sales, such as rent
Variable Costs are the costs that are dependent on the volume of sales, such as the materials needed for production or manufacturing
Factors that Increase a Company’s Break-even Point
It is important to calculate a company’s break-even point in order to know their minimum target to cover their production expenses. However, there are times when BEP increases or decreases, depending on certain factors. Here are some of the factors:
1. Increase in customer sales
When there is an increase in customer sales, it means that there is higher demand. A company then needs to produce more of its products to meet this new demand which, in turn, raises the BEP in order to cover the extra expenses.
2. Increase in production costs
The hard part of running a business is when customer sales or product demand remains the same while the price of variable costs increases, such as the price of raw materials. When that happens, the BEP also goes up because of the additional expense. Aside from production costs, other costs that may increase include rent for a warehouse, increases in salaries for employees, or higher utility rates.
3. Equipment repair
In cases where the production line falters, or a part of the assembly line breaks down, the BEP increases since the target number of units is not produced within the desired time frame. Equipment failures also mean higher operational costs and, therefore, a higher break-even.
How to Reduce the Break-even Point
In order for a business to generate higher profits, the BEP must be lowered. Here are the most effective ways of reducing it.
1. Raise product prices
This is something that not all business owners want to do without hesitation, fearful that it may make them lose some customers.
2. Go for outsourcing
Profitability may be increased when a business opts for outsourcing, which can help reduce manufacturing costs when production volume increases.
Thank you for reading CFI’s guide to Break-Even Point. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below: