The threshold of profitability is a situation in which sales revenues cover fixed costs and variable costs of the company. A prerequisite for calculating the break-even point is the division of the enterprise’s costs into fixed (for example, depreciation) and variables (for example, energy used in the production of materials, wages of production workers).
The breakeven point can be expressed in quantitative terms (how many units of the product should be sold) or in value terms (what price should be reached by the company). At the breakeven point, the company does not bear any losses or profits, the financial result is zero. It should be noted here that cash flow equals depreciation at the breakeven point.
Definition
Break-even point (break-even point) can be defined as the moment at which total costs (expenses) and total sales (revenue) are equal. Break-even is a variant of the absence of net profit or loss. The company is simply breaking even. Any company that wants to be break-even must achieve TBU. Graphically, it looks like the intersection of the curves of total value and total income.
Concept
Break-even point analysis is a definition of safety margin. This usually happens by comparing the amount of revenue to be received with the amount of fixed and variable costs associated with sales or production. In other words, this is a way to calculate when a project will be profitable by equating its total sales revenue with its total costs. There are several different options for using the equation, but they all address management cost accounting.
The main thing to understand in management accounting is the difference between revenue and profit. Not all revenues result in profits for the company. Many products are more expensive than the income they bring. Since expenses exceed revenues, these products bring big losses, not profits.
The purpose of the break-even analysis is to calculate the amount of sales, which equates revenues to expenses. There are many different ways to use this concept.
General methodology
Break-even point is the number of units produced (N) that generate zero profit.
Income - Total Cost = 0.
Total costs = Variable costs * N + Fixed costs.
Income = Unit Price * N.
Unit Price * N - (Variable Costs * N + Fixed Costs) = 0.
So, the breakeven point of sales (N) is:
N = Fixed Costs / (Unit Price - Variable Costs).
About the breakeven point
The origins of the breakeven point can be found in the economic concept of "point of indifference." The calculation of this indicator for the company is quite simple, but high-quality tool for managers and executives.
Break-even analysis in its simplest form helps to understand the amount of income from the sale of a product or service. This indicator signals the ability to cover the corresponding production costs of a particular product. In addition, TBU is also useful for managers, since the information presented can be used in making important business decisions, for example, in preparing competitive offers, setting prices and applying for loans.
Moreover, break-even analysis is a simple tool that determines the minimum number of sales, which will include both variable and fixed costs. This analysis makes it easier for managers to determine the amount of production that can be used to estimate future demand. In a situation where the TBU is above the expected demand, reflecting losses on the product, the manager can use this information to make various decisions. He could abandon the product, improve advertising strategies, or even revise the price of the product to increase demand.
Another important use of the indicator is that TBU helps to recognize the relevance of fixed and variable costs. Fixed costs are less with more flexible and adapted production and equipment, which leads to a decrease in the value of TBU. Therefore, the importance of this indicator for reasonable business and decision-making is unique.
However, the applicability of TBU analysis is influenced by numerous assumptions and factors that may distort the results of the studies.
The most popular calculation formula in physical units
The break-even point is calculated by dividing the total fixed costs (production) by the unit price minus variable costs for this unit of product:
TBUnat = PZ / (C - Before), where TBUnat - break-even point, units;
PZ - fixed costs, t.
C - unit price, t.
Before - variable costs in the unit cost of production, i.e.
Margin Profit Formula
Since the unit price minus the variable costs of the product is the definition of marginal profit per unit, it is possible to simply rewrite the equation as follows:
TBUnat = PZ / MP, where MP is the marginal profit per unit, i.e.
This formula allows you to calculate the total number of units that must be sold so that the company can receive enough revenue to cover all its expenses.
Currency calculation formula
The break-even formula in cost units is calculated by multiplying the price of each unit by the TBU data in physical terms.
TBUden = Ts * TBUnat, where TBU is a monetary expression, t.
C - unit price, t.;
TBUnat- value in physical units, units
This calculation gives us the total amount in value units of sales that the company must receive in order to have zero losses and zero profit.
Calculation formula for breaking even
Now you can take this concept a step further and calculate the total number of units that must be sold to achieve a certain level of profitability using the break-even calculator.
First, we take the desired amount in value units and divide it by margin profit per unit. We calculate the number of units that we need to sell in order to make a profit without taking into account fixed costs. The calculation formula for the breakeven point looks like this:
TBUprib = P / MP + TBUnat, where TBUprib - units of production for profit, units;
P - fixed costs, t.
MP - marginal profit per unit, t.
TBUnat - calculated TBU in physical units, units
Example
Consider an example of each of these formulas. A limited liability company is engaged in the production and sale of products A. Management is not sure that product models A of the current year will bring profit. To do this, you need to measure the number of units that they will have to produce and sell in order to cover their expenses and earn 500 thousand rubles. Here are the production statistics (source data):
- total fixed costs: 500 thousand rubles;
- variable costs in the unit cost of production: 300 rubles;
- selling price per unit: 500 rubles;
- Desired profit: 200 thousand rubles.
First you need to calculate the break-even point per unit, so we will divide the fixed costs of 500, 000 rubles per contribution margin of 200 rubles per unit (500-300 rubles):
500, 000 / (500 - 300) = 2, 500 units.
As you can see, an organization will have to sell at least 2, 500 units to cover fixed and variable costs. Everything that will be sold after the mark of 2, 500 units of production will go directly to profit, since fixed costs are already covered. In this situation, we can talk about a profitable business.
Then you need to convert the number of units into total sales, multiplying 2, 500 units by the total selling price for each unit of 500 rubles.
2, 500 units * 500 = 1, 250, 000 rubles.
Now the management of the LLC may decide that the company must sell at least 2, 500 units or the equivalent of sales may be 1, 250, 000 rubles before any profit is made.
A company can also take it one step further and use the breakeven point calculator to calculate the total number of units that must be produced to achieve its yield goal of 200, 000 rubles, dividing the desired profit of 200, 000 rubles by the contribution margin, and then adding the total number breakeven units:
200, 000 / (500 - 300) + 2, 500 = 3, 500 units.
Analysis
There are many different ways to use the enterprise breakeven concept. Managers should be clearly aware of the required level of sales and how close it is to fixed and variable costs. That is why management is constantly trying to change the elements in the formulas in order to reduce the number of units needed for production and sales, and increase profitability.
For example, if management decides to increase the selling price of products A in our example by 50 rubles, then this will have a radical impact on the number of units needed to make a profit. It is possible to change the variable costs for each unit, adding more automation to the manufacturing process. Lower variable costs equal more profit per unit and reduce the total quantity that must be produced. Outsourcing can also change the cost structure.
Margin of safety
When considering how business profitability is calculated, the concept of safety margin arises. It is understood as the difference between the number of units needed to achieve the goal of profit, and the number of units that must be sold to cover costs. In our example, the firm had to produce and sell 2, 500 units to cover its costs. It is necessary to produce 3, 500 units in order to achieve your goals. This scatter of 1, 000 units is a safety margin. This is the amount of sales that the company can afford to lose, while covering its costs.
It is also important to remember that all of these models reflect non-cash expenses, such as depreciation. A more advanced break-even analysis calculator would subtract non-cash costs from fixed costs to calculate the cash flow level at the break-even point.
