Sunday, 29 March 2015

What is Break-Even-Point?

Break-even point refers to an optimal level of business activities of any firm where cost of production and price match each other. It is a stage where there is no profit or loss in the business. Total revenue matches with total costs.From this point, you can reach towards profit by improving your operations efficiently or, on the other hand, may incur losses due to mismanagement and defective planning.

Definition of Break Even Point
Break-Even-Point can be defined as a point in business scale where the value of total costs equal to total sales or revenue at any point of time. It is a point where expenses equal to income and there is neither profit nor loss in the operations of business. The operations of sales and production of the business break even at this point in a curve or lines joining the costs and revenues.

Importance of Break-even point
  • Break-even point is very helpful in calculating the minimum level of output that is to be crossed to make profits in business. Or, in other words, you can know about the minimum sales that are required to be made to meet out all expenses and make an extra unit of profit.
  • The business man is able to know the minimum number of units required to be produced and sold to level both his fixed costs and variable costs so that with an extra unit sold he can start making profit.
  • So, break-even point calculation can be used by management in setting the prices of products and in determining the minimum sales target to be achieved by them.
  • Further, it is very useful in controlling your fixed costs as you are able to know the impact of fixed costs on your performance level.
Calculation of Break-even Point
Break-even point is calculate with the assumption that Total Cost= Total Revenue or income.
Now, total cost includes both Total Fixed Cost and Total Variable Cost.

Total Fixed Cost is your fixed expense which more or less remains the same. But Variable Cost is related to number of units produced. So Total Variable Cost depends upon your production and sales quantity. So, let us assume that Variable Cost multiplied by the number of units gives you the Total Variable Cost. If Variable Cost is V and number of units is X, then Total Variable Cost = V*X (Variable cost multiplied by X units).

Let Total Fixed Cost be TFC. and Total Revenue be TR. But TR is Price of product multiplied by number of units produced or sold. So, let TR be equal to P*X (Price multiplied by X units)

Now, Break even point or BEP will be equal to TFC + VX = PX or to change the position,
TFC= PX- VX  = X (P-V)

To deduce the number of units required to be produced or sold, the equation will be
X = TFC divided by P-V

If we give values to above concepts:- Suppose TFC = 1,000,000 and P is 100 and V is 60.

From above formula of X = TFC/ (P-V), so, 1000000 divided by (100- 60) ie. 1000000 divided by 40.

So, the number of units required to produce and sell is 25,000 units. This is the Break-even production or Break-even sales to be achieved in order to realize the full expenses incurred by the business.

Benefits of using Break-Even-Point concept

  • By using this method, you are able to know the production and sales targets to be achieved by your business during any period of business.
  • You can control the costs and production levels according to your available options to achieve maximum benefits and to reap profits.
  • In the above example, if you feel it is difficult to achieve the production of 25,000 units, then you may consider other options like reducing your Total Fixed Cost or reduce the Variable Cost or you may even consider of increasing the selling price of your product to meet the expenses.
  • You can plan your future plans and build budgets and projects with the help of this break-even method of concept.

Limitations to application of Break-Even-Point
There are some limitations in applying this method as it is based on some pre-assumptions.

  • Break-even concept assumes that Fixed Costs are constant. But in actual cases, fixed costs also change when there is large scale increase in production or sales as you require to employ more staff and hire more space for increased activities and many other expenses also increase.
  • This concept again assumes that variable cost is constant during the entire period of application of this concept. If there is any slight variation in the variable cost during the period of application, then also, the entire calculation will become useless and all predictions will go wrong.
  • This method does not take into account the stock of inventory as it assumes that production quantity is equal to sales quantity.
  • It further assumes that in multiple product companies, the mix ratios of production are equal to the mix ratios of sales. It considers that the relative ratios between different products are maintained same as that of sales.

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