The breakeven point (also known as neutral) is a business term that refers to the point of activity where revenues are equal to costs; that is, at the point of activity where there is no gain or loss.

Knowing the balance point of a company allows us to know the level or volume of sales where revenues are equal to costs and, for example, to know how much we have to sell to cover our costs, or how much is what we have to sell to start generating profits.

The analysis of the equilibrium point of a company, in general terms, allows us to financially analyze this and thus, based on said analysis, to be able to make decisions.

What is the breakeven point

The breakeven point (also known as neutral) is a business term (being specific, typical of cost accounting ) that refers to the point of activity where revenues are equal to costs; that is, at the point of activity where there is no gain or loss.

In the case of a company, the breakeven point refers to the level or volume of sales where revenues are equal to costs and, therefore, to the level or volume of sales where there is no profit or loss.

What is the usefulness of the breakeven point?

Knowing the balance point of a company allows us to know the level or volume of sales where revenues are equal to costs and thus, for example:

  • Know how much we have to sell to cover our costs (how much we have to sell to reach the breakeven point).
  • Knowing how much we have to sell to start generating profits (how much we have to sell to overcome the breakeven point).
  • Control our costs (by ensuring that these do not exceed the breakeven point).
  • Having a base on which to plan our sales and the profits we want to have (once we know what the breakeven point is, it is easier to plan how much we want to sell or earn).
  • Have a basis on which to set the prices of our products or services (once we know what the breakeven point is, it is easier to determine our prices).

Generally, the equilibrium point of a company is calculated and analyzed; However, it is also possible to calculate and analyze the equilibrium point of other elements of this such as:

  • An area or department: for example, to know how much you should generate in revenue to exceed your costs, and thus begin to be profitable.
  • A certain product: for example, to know how many we have to sell to exceed its costs, and thus start generating profits.
  • An investment project: for example, to know how much you should generate in income to recover your investment, and thus be considered viable.
  • A customer: for example, to know how much you have to buy us to overcome the costs generated, and thus be considered profitable.

Likewise, the breakeven point is usually calculated and analyzed when an investment is going to be made (for example, in the creation of a company, the launch of a product, or a marketing campaign) in order to know how much it is and what it has to be sold to cover the investment.

How to calculate and analyze the breakeven point?

Here are the steps necessary to calculate and then analyze the breakeven point of a company.

1# Determine costs

First, we must determine what expenses we will consider as costs.

The usual thing when calculating the breakeven point of a company is to consider as costs all expenses related to the product; that is, to all expenses related to:

  • Acquisition of merchandise: in the case of a marketing company (for example, merchandise, transport, storage, etc.).
  • Production of the product: in the case of a producing company (for example, the first matter, the fuel necessary for the operation of the machines and equipment, the maintenance of these, etc.).
  • Provision of the service: in the case of a service company (for example, the inputs necessary to provide the service, the salaries of the workers dedicated to providing the service, etc.).
  • Including administration expenses (for example, salaries of managers and administrators, rents, basic services, etc.), and sales expenses (for example, salaries of vendors, advertising, etc.); but not financial expenses (payment of acquired debts) or taxes (total cost accounting method of costs ).

However, when it comes to a small business, it is advisable to consider all business expenses as costs, including financial expenses and taxes.

2# Classify costs into Variable Costs and Fixed Costs

Once we have determined which expenses we will consider as costs, we proceed to classify these into Variable Costs (CV) and Fixed Costs (FC):

Variable Costs: variable costs are costs that vary (increase or decrease) depending on changes in activity levels (the number of units sold in the case of a trading company, the volume of production in the case of a producing company or the number of services provided in the case of a service company).

Examples of variable costs are raw materials, fuels, spare parts, packaging, hourly wages, etc.

Fixed Costs: fixed costs are costs that do not vary based on changes in activity levels but remain fixed. Examples of fixed costs are rents, maintenance of machines and equipment, depreciation, insurance, fixed wages, and salaries, etc.

3# Find Unit Variable Cost

Once we have divided the costs into Variable Costs and Fixed Costs, we proceed to find the Unit Variable Cost (UVC), which is obtained by dividing the Total Variable Costs by the number of units sold.

4# Apply breakeven formula

Once we have obtained the Unit Variable Cost, we proceed to apply the formula to find the equilibrium point, which is as follows:

Pe = FC / (USP- UVC)

Where:

  • Pe: breakeven point (units to be sold in such a way that the income is equal to the costs).
  • FC: Fixed costs.
  • USP: Unit Sale Price.
  • UVC: Unit Variable Cost.

The result obtained through this formula will be in physical units. If we want to find the equilibrium point in monetary units, we simply have to multiply the result by the sale price.

5# Check results

Once we have calculated the equilibrium point, we proceed to check the result through the explanation of a statement of results, where we must ensure that the profits are equal to 0.

6# Analyze break-even point

Finally, once we have calculated the equilibrium point and verified the result through the explanation of a statement of results, we proceed to analyze it; For example, to know how much we need to sell to cover our costs, or how much we must sell to start general profits.

Example of how to calculate and analyze the breakeven point

Let’s see below an example of how to calculate and subsequently analyze the equilibrium point of a company following the steps that we have described above.

A company dedicated to the marketing (purchase and sale) of shirts. The company sells shirts at a price of US $ 40, the cost of each shirt is the US $ 24, a sales commission is paid for US $ 2, and its fixed expenses (rent, salaries, basic services, etc.) amount to the US $ 3,500.

What is the breakeven point in sales units and in monetary units?

Finding the breakeven point:

USP= 40

  • In the event that a product has several sales prices, to determine the unit sale price we must find an average unit sale price.

UVC: 24 + 2 = 26

FC= 3500

Applying the equilibrium point formula:

Pe = FC/ (USP- UVC)
= 3500 / (40 – 26)

Pe = 250 units.

Pe in monetary units: 250 x 40 = US $ 10,000

Checking:

Sales (USP x Pe): 40 x 25010,000
(-) (UVC x Pe): 26 x 2506,500
(-) FC3,500
Net profit0

Analyzing the equilibrium point obtained, we can obtain the following conclusions:

  • The breakeven point is 250 units, which means that 250 shirts need to be sold so that the income is equal to the costs (there is no profit or loss), from the sale of 251 shirts it would be just beginning to generate profits , and the sale of 249 shirts or a smaller amount would mean losses.
  • The equilibrium point in monetary units is US $ 10,000, which means that you need to sell the US $ 10,000 in shirts so that revenues are equal to costs, sales greater than that amount would mean profits, and sales less than that amount would mean losses.
  • If, for example, 200 shirts had been sold then 51 shirts would have to be sold to overcome the breakeven point and, therefore, to start generating profits and the shirts are considered a profitable product.
  • As an additional note, when selling 250 shirts the income would equal the costs and, therefore, the profits would be the US $ 0; but if, for example, 800 shirts were sold, then the profits would amount to the US $ 7,700:
Sales (USP x Pe): 40 x 80032,000
(-) (UVC x Pe): 26 x 80020,800
(-) FC3,500
Net profit7,700

Summary

The breakeven point is the point of activity where revenues are equal to costs and, therefore, the point of activity where there is no gain or loss.

Knowing the balance point of a company allows us to know the level or volume of sales where revenues are equal to costs and, for example, to know how much we have to sell to cover our costs or to start generating profits.

Generally, the breakeven point of a company is calculated and analyzed; however, it is also possible to calculate and analyze the equilibrium point of other elements of this, such as a product or a customer; for example, to know how much they should generate in income to be considered profitable.

Finally, in addition to the breakeven point, there are other financial tools that also allow us to financially analyze a company or evaluate an investment project, such as ROI, NPV and IRR, and the cost-benefit ratio.

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