Every business involved in the manufacturing or production of goods should be aware of the break even analysis. With the help of the break even analysis formula, you are able to calculate your break-even point. It is the point at which the total expense equals the total revenue. So, there is no net profit earned or any loss incurred by the business at the break-even point. Let’s take a look at the break even analysis in more detail.
Break Even Analysis
The break even analysis can be presented in form of the number of units or the amount of revenue earned. For any company, there are two types of costs-fixed cost and variable cost. The fixed cost remains fixed for a considerable period of time. As and when the level of production reaches beyond the optimal limit, the fixed would increase. This cost is incurred by the firm even when they are no units produced. Examples include salary to the supervisor, rent, power bills. The firm is liable to pay for these costs irrespective of the level of units produced or not.
Variable cost is the cost incurred in the production of units. The total variable cost varies with a change in the number of units produced. Examples include the cost of raw materials, labor. Break even analysis helps a firm to determine the number of units it needs to produce and sell in order to reach the point of no profit and no loss-the break-even point. Anything that is sold over and above the break-even point contributes to the profitability of the firm.
Break Even Analysis Formula
Let’s understand this concept with the help of an example. Suppose, XYZ Ltd. produces and sells product P at $10. The cost incurred for Product P is $5 each and the total fixed cost amounts to $1,00,000. Now the firm needs to determine the number of units it needs to produce and sell in order to reach the break-even point. Now the break-even point in quantity (units) is given by Total Fixed Cost/Selling Price- Variable Cost (per unit). The difference between the selling price and variable cost is known as contribution for the firm. Therefore, the formula can also be written as Total Fixed Cost/Contribution per unit.
Fixed Cost = $1,00,000
Selling Price per unit = $10
Variable Cost per unit = $5
Therefore, break-even point in quantity = 1,00,000/ 10 – 5
break-even point in quantity = 1,00,000/5
break-even point in quantity = 20,000 units
This means that XYZ Ltd. needs to sell 20,000 units of Product P to reach the break-even point.
To calculate the break-even point in the sales figure, you need to multiply the selling price per unit of Product P by the break-even quantity. That is 20,000 units X $10 (selling price) = $2,00,000. Therefore, XYZ Ltd. needs to sell goods worth $2,00,000 to reach the break-even point.
The break even analysis can also be calculated in terms of total revenue and total cost as shown below.
Break-even is the point at which total revenue equals total cost.
Therefore, Total Revenue = Total Cost
Selling Price x No. of units sold = Variable Cost x No. of units + Total Fixed Cost
Selling Price x No. of units sold - Variable Cost x No. of units = Total Fixed Cost
(Selling Price - Variable Cost) x No. of units = Total Fixed Cost
(Contribution) x No. of units = Total Fixed Cost
No. of units = Total Fixed Cost/ (Contribution)
Therefore, when you calculate your break-even point, it helps you to figure out the right numbers of units before you begin to make profits. This is very useful when it comes to understanding the time frame before you earn profits and accordingly you can adjust your costs. A good understanding of break even analysis can help you to take the right decisions for your day-to-day activities and also control and avoid cash flow mistakes for your firm. To know more about how you can use the break even analysis for your benefit, get in touch with a professional accounting firm in Edmonton.