The Uses of the Break-Even Point in Finance
The break-even point can be used in a variety of ways in business; however, the most common uses for the break-even point is to set prices and determine costs. Prices and costs are at the basis of all key assumptions associated with a company's financial statements. The break-even point determines the price and quantity at which a company is realizing neither financial gain, nor loss.
Other People Are Reading
-
Neccessity
-
The break-even point is the amount of revenue that a company must generate in order to equal its expenses. This is the point at which total revenue and total costs are equal. Above the break-even point, total revenue will exceed total costs and create a financial gain. Below the break-even point, total costs exceed total revenue and result in a loss.
Calculating the Break-Even Point
-
The break-even point equals fixed costs divided by the unit selling price – variable costs. The result of this calculation will be the number of units a company must sell in order to not to have a financial loss or gain. This figure can be used to determine the costs associated with producing the break-even quantity. Costs can be both fixed and variable.
The break-even formula is as follows:
Break-even = fixed costs /(unit selling price – variable costs)
-
Using the Break-Even Point to Set Prices
-
One of the most critical functions of the break-even point is to set unit prices. The term "unit price" refers to the amount of money you plan to charge customers to purchase an individual unit of your product. A company begins to make a profit only when its sales revenue exceeds the break-even point. This function of the break-even point is critical, since it is not possible to calculate revenue without having a specific unit price.
Using the Break-Even Point to Determine Costs
-
The break-even point enables you to pinpoint the total costs associated with meeting a certain revenue target. This total cost is made up of fixed and variable costs. Fixed costs are costs that remain the same regardless of how many items you sell (such as rent payment). Variable costs change in proportion to a company's activity in business (such as payroll). This information is essential for setting sales targets.
Cost Formulas:
Total Costs = Fixed Costs + Variable Costs
Variable Costs = Cost per unit * Number of Units
Fixed Cost = Total costs – Variable costs
-
