Friday, October 1, 2010
Break Even Point
Posted on 2:31 PM by Logu's Web Page
Break even point is the level of sales at which profit is zero. According to this definition, at break even point sales are equal to fixed cost plus variable cost. This concept is further explained by the following equation:
[Break even sales = fixed cost + variable cost]
The break even point can be calculated using either the equation method or contribution margin method. These two methods are equivalent.
How do calculate the break even point?
Assume the following:
Fixed Costs: | |
Monthly Rent | 500 |
Insurance | 250 |
Total Monthly Fixed Costs | 750 |
Variable Cost: | |
Materials | 15 |
Labor | 20 |
Total Variable Cost | 35 |
Selling Price: | 50 |
Calculation:
Break Even Point = | Fixed Costs / (selling price - variable costs) |
Break Even Point = | 750 / (50-35) |
Break Even Point = | 750 / 60 |
Break Even Point = | 50 |
To break even the company must sell 50 units per month. | |
Benefits / Advantages:
The main advantages of break even point analysis are that it explains the relationship between cost, production, volume and returns. It can be extended to show how changes in fixed cost, variable cost, commodity prices, and revenues will affect profit levels and break even points. Break even analysis is most useful when used with partial budgeting, capital budgeting techniques. The major benefits to use break even analysis are that it indicates the lowest amount of business activity necessary to prevent losses.
Limitations of Break Even Analysis:
It is best suited to the analysis of one product at a time. It may be difficult to classify a cost as all variable or all fixed; and there may be a tendency to continue to use a break even analysis after the cost and income functions have changed.
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