How to Calculate the Break-Even Point – Forbes Advisor INDIA

In this age of startups and unicorns, every savvy businessman wants to know when their business is profitable or when it will hit a break-even point (BEP)? There are also other questions like: Is it better to change the price structure to make profits or how to make more profits than just recurring losses? It is the break-even point analysis that helps to find out the answers to these above questions.

So what exactly does the break-even point mean and at what stage does one reach it? Here is a detailed guide on what the break-even point means and how to determine and calculate it.

What is the break-even point?

The break-even point is used in a variety of ways in economics, finance, and investing. BEP analysis is considered to be a crucial and important financial tool that helps a company determine the stage at which the company or a new product is said to be profitable.

When the break-even point is reached, a company makes neither profit nor loss and is therefore referred to as a no-profit or no-loss point. BEP just shows that all costs are covered, which means:

Revenue = Total Variable Costs + Total Fixed Costs

How do you calculate the break-even point?

Calculation of deal break-even point

The break-even calculation is applied to a variety of contexts. For example, in the world of finance and business, the break-even point refers to the stage where total costs and total revenues become equal.

This BEP analysis helps determine the number of units or revenue needed to cover the total cost. The total costs are made up of fixed and variable costs. Most of the time, low fixed costs have a low break-even point of sale.

Fixed costs: These are also known as overheads, or expenses that stay the same and don’t change with the different services, such as loan payments, rent, insurance, or taxes. This simply means that even with zero production, the fixed costs must be incurred.

Variable costs: These are the expenses that are directly related to the volume of production of the company. Variable costs change depending on how much a company produces or sells units such as electricity costs, packaging and raw material costs, wages.

Break-even point per unit formula

• Break-Even Point per Unit = Fixed Cost / (Selling Price per Unit – Variable Cost per Unit)

Break-even point in sales (INR) formula.

• Break-Even Point in Sales (INR) = Fixed Costs / Contribution Margin

*The Contribution Margin = (Selling Price per Unit – Variable Cost per Unit) / Selling Price per Unit

For example:

• Variable costs per unit: INR 400
• Selling price per unit: INR 600
• Desired Profit: INR 4 lakh
• Total fixed cost: INR 10 lakh

To calculate the break-even point per unit, divide the INR 10,00,000 (Fixed Cost) by the INR 200 which represents the contribution per unit calculated as: INR 600 – INR 400 (Revenue/Unit – Variable Cost/ Unit)

Break-even point (unit) = 10,00,000 INR/ 200 INR = 5000 units.

To derive the breakeven point in INR: Multiply 5,000 units by the selling price of INR 600 per unit.

Break even sales at 5,000 units x 600 INR = 30 lakh INR (break even point in rupees)

Calculation of the break-even point of the investment

However, in the world of investing, the break-even point is when an asset’s market price is equal to its original cost. Let’s see an example of how the BEP is calculated in relation to the stock market and options trading.

Example 1: An investor buys company XYZ shares at INR 100, this price point is now its breakeven point for trading. So, if the price moves above INR 100, the investor is obviously making money. And if the stock falls below INR 100, they lose money.

So if the price stays at INR 100, they are very good at the BEP because at that price point the investor does not make or lose anything.

Example 2: The break-even point is calculated differently in options trading. For example, if an investor pays INR 10 as a premium for a stock call option and the exercise price is INR 100. Then the breakeven point equals the premium plus the strike price, i.e. 110 INR. Well if this is applied to a put option then the breakeven point would be calculated as the strike price of INR 100 minus the premium paid of INR 10 which amounts to INR 90.

When can break-even point analysis be used?

• Business start-up or start-up: A break-even analysis becomes very important when building your new business. It maps the profitability of the business and also helps in pricing.
• Introduction of a new product or service: If the business is already up and running and a product or service is newly launched, it would be beneficial for the company to do the BEP analysis before launching the product.
• Change of business model: If there is a planned change in business model, for example moving from retail business to online wholesale business, then it becomes important to calculate the BEP analysis as it also gives a fair idea of ​​pricing and costs.

Why is it important to calculate the break-even point?

• BEP analysis helps to show the maximum profit that a particular product or service can generate.
• It helps determine the idle capacity of any business once it breaks even.
• You can also see the profit change when the price of the product has increased or decreased.
• You’ll learn how much your business needs to sell to be profitable, helping you set more specific sales goals.
• Helps in raising the funds for the business as the break-even analysis allows you to prove to outsiders that your business plan is viable and get funds based on that.
• Finally, it helps in the pricing of the products, which is the most important decision of any business. BEP as a tool offers the best price for a product that can generate maximum profit.

The final result

The break-even point is an important financial metric that helps analyze the business and its viability. It definitely helps reduce risk, set pricing and targets, helps with additional funding, but over the long term it can’t be the only tool to assess a company’s financial health.