Definition of Break Even Point Essay
Definition of Break Even point: 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 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. Equation Method: The equation method centers on the contribution approach to the income statement.
The format of this statement can be expressed in equation form as follows: Profit = (Sales ? Variable expenses) ? Fixed expenses Rearranging this equation slightly yields the following equation, which is widely used in cost volume profit (CVP) analysis: Sales = Variable expenses + Fixed expenses + Profit According to the definition of break even point, break even point is the level of sales where profits are zero. Therefore the break even point can be computed by finding that point where sales just equal the total of the variable expenses plus fixed expenses and profit is zero.
Example: For example we can use the following data to calculate break even point. |Sales price per unit = $250 | |variable cost per unit = $150 | |Total fixed expenses = $35,000 | |Calculate break even point | Calculation: Sales = Variable expenses + Fixed expenses + Profit | |$250Q* = $150Q* + $35,000 + $0** | |$100Q = $35000 | |Q = $35,000 /$100 | |Q = 350 Units | |Q* = Number (Quantity) of units sold. |**The break even point can be computed by finding that point where profit is zero | The break even point in sales dollars can be computed by multiplying the break even level of unit sales by the selling price per unit. 350 Units ? $250 Per unit = $87,500 Contribution Margin Method: The contribution margin method is actually just a short cut conversion of the equation method already described. The approach centers on the idea discussed earlier that each unit sold provides a certain amount of contribution margin that goes toward covering fixed cost.
To find out how many units must be sold to break even, divide the total fixed cost by the unit contribution margin. |Break even point in units = Fixed expenses / Unit contribution margin | | $35,000 / $100* per unit | | 350 Units | |*S250 (Sales) ? $150 (Variable exp. ) | A variation of this method uses the Contribution Margin ratio (CM ratio) instead of the unit contribution margin.
The result is the break even in total sales dollars rather than in total units sold. |Break even point in total sales dollars = Fixed expenses / CM ratio | |$35,000 / 0. 40 | |= $87,500 | This approach is particularly suitable in situations where a company has multiple products lines and wishes to compute a single break even point for the company as a whole.
Benefits / Advantages of Break Even Analysis: The main advantages of break even point analysis is 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, revenues will effect 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 is that it indicates the lowest amount of business activity necessary to prevent losses.