The breakeven point is an important concept for business stakeholders and investors since it enables well-informed decisions and better insight into financial performance.
In this blog, we breakdown the breakeven point for you:
- What is the breakeven point?
- How to calculate the breakeven point
- The importance of the breakeven point for businesses
- How to use the breakeven point to make financial decisions
You will also find useful graphs and formulas to help with your understanding of this concept – whether you’re a seasoned investor, or a budding entrepreneur.
Table of Contents
What is Breakeven Point?
Simply put, breakeven is the point at which costs equal incomes. In business, breakeven is achieved when the revenue earned by a company equals the costs associated with production and selling.
In other words, the breakeven point is the level of sales that a company must achieve in order to cover its fixed and variable costs.
Fixed costs are expenses that do not change regardless of the level of production or sales, such as rent or salaries. Variable costs, on the other hand, are expenses that do vary with the level of production or sales, such as raw materials or labour costs.
Breakeven Point in Investing
In investing, the breakeven point is the price at which an investor has neither made nor lost money on an investment. It is calculated by dividing the total cost of the investment by the number of shares purchased.
For example, if an investor buys 100 shares of a stock at Rs 10 per share, their breakeven point is Rs 1000. If the stock price goes up, the investor makes a profit. If the stock price goes down, the investor makes a loss.
Breakeven helps investors determine how much they are willing to lose on investment and set realistic expectations for their returns. Here are some of the factors that can affect the breakeven point of an investment:
- Investment price: The higher the price of the investment, the higher the breakeven point.
- Number of shares: The more shares purchased, the higher the breakeven point.
- Investment costs: These costs can include commissions, fees, and taxes.
- Investment volatility: The more volatile the investment, the higher the breakeven point.
Types of Breakeven Points
There are three main types of breakeven points that businesses can calculate:
| Type | Definition |
|---|---|
| Unit breakeven point | The number of units a business needs to sell in order to cover its total costs and break even. |
| Revenue breakeven point | The level of revenue a business needs to generate in order to cover its total costs and break even. |
| Time breakeven point | The amount of time it takes for a business to break even, based on its fixed costs, selling price, and variable costs per unit. |
How to Calculate Breakeven Point?
Step one to calculating the breakeven point is determining these basic metrics.
- Fixed costs
- Variable cost
- Product selling price
- Total sales
Step two is to calculate the weighted average contribution per unit and the sales mix from these metrics.
| Term | Definition | Formula |
|---|---|---|
| Sales mix | The percentage of total sales that each product contributes. | Sales mix = Sales of product / Total sales |
| Unit contribution margin | The amount of money that a business makes from selling one unit of a product after subtracting the variable costs associated with producing that unit. | Unit contribution margin = Selling price - Variable costs |
Step three is to calculate the weighted average contribution margin ratio. The formula for this is:
Weighted avg contribution margin ratio = Σ(Unit contribution margin * Sales mix) / ΣSales
Once these values are determined, the breakeven point can be calculated with the following formulas.
| Breakeven Point | Formula |
|---|---|
| Unit breakeven point | Total fixed costs / Weighted average contribution margin per unit |
| Revenue breakeven point | Total fixed costs / Weighted average contribution margin ratio |
| Time breakeven point | Total fixed costs / (Weighted average selling price per unit - Weighted average variable costs per unit) / 12 |
*The 12 here represents 12 months. If you want a yearly number, skip dividing by 12.
Example of Break-Even Analysis
Suppose you run a business that offers two products: Product A and Product B.
| Product | Selling price | Variable cost |
|---|---|---|
| A | 100 | 60 |
| B | 50 | 30 |
To calculate the unit breakeven point, you would first calculate the weighted average contribution margin per unit:
[(100 x (Rs 100 – Rs 60)) + (200 x (Rs 50 – Rs 30))] ÷ (100 + 200) = Rs 50
Then, you would divide the total fixed costs by the weighted average contribution margin per unit:
Rs 20,000 ÷ Rs 50 = 400 units
This means you would need to sell 400 units across both products per month to break even.
To calculate the revenue breakeven point, you would first calculate the weighted average contribution margin ratio:
[(100 x (Rs 100 – Rs 60)) + (200 x (Rs 50 – Rs 30))] ÷ [(100 x Rs 100) + (200 x Rs 50)] = 0.417
Then, you would divide the total fixed costs by the weighted average contribution margin ratio:
Rs 20,000 ÷ 0.417 = Rs 47,965
This means you would need to generate Rs 47,965 in revenue across both products per month to break even.
To calculate the time breakeven point, you would first calculate the weighted average selling price per unit and the weighted average variable cost per unit:
[(100 x Rs 100) + (200 x Rs 50)] ÷ (100 + 200) = Rs 66.67 (weighted average selling price per unit)
[(100 x Rs 60) + (200 x Rs 30)] ÷ (100 + 200) = Rs 40 (weighted average variable cost per unit)
Then, you would use the following formula to calculate the time breakeven point:
Rs 20,000 ÷ (Rs 66.67 – Rs 40) ÷ 12 = 4.17 years
This means it would take you 4.17 years to break even, assuming your sales and costs remain constant.
Benefits of Breakeven Analysis
There are several benefits of conducting a breakeven analysis for a business:
- Helps in determining pricing strategy: A break-even analysis helps determine the minimum price businesses need to charge in order to cover all costs and make a profit.
- Provides insights into cost structure: By analyzing the fixed and variable costs of the business, a break-even analysis can provide valuable insights into the cost structure of the business. This can help businesses identify areas to reduce costs or increase efficiency.
- Helps in decision-making: A break-even analysis can be used to evaluate the financial impact of different business decisions, such as introducing new products, expanding into new markets, or investing in new equipment. This information can help businesses make more informed decisions and minimize financial risk.
- Improves budgeting and forecasting: A break-even analysis can help businesses develop more accurate budgets and forecasts by providing a clear picture of their revenue and cost structure. This can help businesses plan for future growth and avoid financial surprises.
- Provides a benchmark for performance: By regularly conducting a break-even analysis, businesses can track their financial performance over time and compare it to industry benchmarks. This can help businesses identify areas where they need to improve and make strategic adjustments to improve their profitability.
Break Past the Breakeven Point
One of the first major milestones in the journey to business success is reaching breakeven. No business can become profitable without first breaking even.
To reach breakeven, businesses need to pay special attention to financial management and health. A big part of this is optimising your business banking functions.
Frequently Asked Questions
What is the breakeven point?
The breakeven point is the level of sales at which a business neither makes a profit nor incurs a loss. It's the point where the total revenue earned is equal to the total costs incurred.
Why is the breakeven point important for businesses?
The breakeven point is important because it helps businesses determine the minimum amount of sales or revenue needed to cover their costs and achieve profitability. It can also be used to set pricing strategies, make informed business decisions, and identify areas for improvement.
How do you calculate the breakeven point?
To calculate the breakeven point, you need to know your fixed costs, variable costs, and selling price per unit. The formula is: Breakeven Point = Total Fixed Costs / (Selling Price per Unit - Variable Costs per Unit)
What are the different types of breakeven points?
The different types of breakeven points include unit breakeven point (the number of units needed to sell to break even), revenue breakeven point (the amount of revenue needed to generate to break even), and time breakeven point (the amount of time it will take for your business to break even).
How can breakeven analysis help businesses?
Breakeven analysis can help businesses in several ways. It can provide insights into cost structure, help in decision-making, improve budgeting and forecasting, and provide a benchmark for performance.
What are some factors that can affect the breakeven point?
Some factors that can affect the breakeven point include changes in fixed costs, variable costs, the selling price per unit, and sales volume. Changes in market conditions, competition, and technological advancements can also affect the breakeven point.
