Calculation of break-even point: the necessary knowledge for a novice businessman
Let us try to explain the essence of the frequently used term “break-even point” in order to help understand the formula for calculating it and subsequently use this economic tool productively in business.
Break-even point: when it is calculated
Since any business aims to maximize profits, a businessman needs to correctly predict the development of production, especially its new areas. Therefore, there is a need to calculate its effectiveness, assess risks, the volume of investments, and establish payback periods before starting a project. An economic indicator, the break-even point, will help to carry out a similar analysis. It is about her talk.
Break-even calculation: the value of the company
The result of the calculation of this indicator is the determination of the necessary to cover the cost of sales. The break-even point shows the level of sales at which there is no profit or loss, and can be calculated in terms of value and in kind. Calculated in physical terms, this indicator determines the number of units of a product or service that is necessary for realization in order to cover all costs incurred and reach a zero level of profit. A value expression shows how much this product should be sold. If, when summarizing the results for the reporting period, the volume of sales does not reach the level of calculated break-even, this indicates that production is currently unprofitable and incurs losses. If the sales volume exceeds the calculated figure, this means that the organization, having covered the expenses, makes a profit.
This indicator is used in the analysis of the company. For example, speaking of financial stability, the economist compares the dynamics shown by the break-even point: an increase in the indicator indicates the emergence of various problems in the company, which led to a larger sales volume in order to cover the costs incurred.The reasons for the growth of this indicator may be different: the expansion of production or a radical change in its structure, price fluctuations in the market, the effects of inflation, etc. The break-even point is usually calculated for individual projects. For example, for a competent business, they predict the possibility of optimal changes in sales volumes and product costs, calculating non-critical values of revenue decline in order to increase sales, working without loss.
The calculation is based on data from cost accounts.Costs are divided into fixed and variable. The first include unchanged from month to month, for example:
• depreciation of equipment;
• salary of administrative staff and social charges;
• payments for rent, communications, utilities, etc.
Fixed costs are subject to changes in non-productive nature, for example, increased capacity, energy tariffs, rent fees, the impact of inflation and other factors. Variable costs are the costs of purchasing production raw materials and materials, paying for fuel and energy resources involved in the work process, the salary of workers (with deductions), etc. Their value depends on the volume of output and sales.
How to calculate the indicator in physical terms?
For calculation in physical units, the following basic information will be required:
• total fixed costs - Pfast;
• unit price - Ced;
• variable costs per unit - Pbefore.
The break-even point is calculated using the formula:
Tbed= Pfast/ (Ced- Rbefore)
It shows the realization of the product in units for reaching zero profit.
Calculation in terms of value
Calculations in monetary terms use the following data:
• total fixed costs - Pfast;
• revenue - B;
• product price - Ced;
• total variable costs (Pper) and per unit of goods (Pbefore).
The calculation consists of several stages:
• according to the formula Dm= B - Pper.find marginal income (Dm) - the difference between revenue and variable costs;
• on this basis, calculate the coefficient of marginal income (Kdm) in the total amount of revenue received by the formula Kdm= Dm/ AT;
• break-even point in cash equivalent: TBden= Pfast/ Kdm
Calculation of the break-even point per product unit by marginal income
Predicting new directions in developing business, they often use indicators of price and variable costs per unit of goods, based on the formula:
Dhoney= C - Pbefore,
where is Dhoney- marginal income per unit.
Calculate the coefficient of marginal income by comparing its value with the price per unit of goods, because in this case it is the revenue in its implementation:
TOdm= Dhoney/ Cunits
Get the same value of the ratio as when calculating the total sales. The break-even point in monetary terms can be calculated by the formula:
Tbden= Pfast/ Kdm.
The calculation of losses that need to be covered is sometimes called the threshold of profitability, since it gives an idea of the necessary volume of production and sale of goods or services in physical and value terms for the company's exit to make a profit. This indicator is often necessary for beginning businessmen or forecasting and analyzing the further development of production, since, counting on the break-even of one’s own enterprise, one can foresee difficulties and protect oneself from them.