Determination and need for a break-even
The break-even point in a business is when the revenue equals the expenditure.
If this is not the case, then the company as a whole or just the observed part is surely will generate a loss during the year.
The sooner you can achieve during production, the easier it will be to achieve a positive result.
The break-even also provides an opportunity to compare the management of two companies, but be aware that you can only do this for companies operating in the same area. This is because the result will be completely different for a company with high asset requirements than, say, a service provider.
At the end of the article you will find a calculator with which you can also calculate your own break-even.
Why is the break-even point important?
At the company level, it shows how easy it is to achieve success with a given business.
You can calculate how much production and sales it takes for your company to make a profit by crossing the break-even point. Until you cross this point, you will have a loss.
Monitoring the coverage point provides information that:
- Which activity(ies) take up the most resources?
- Is the company on the right track to achieving its goals?
- Is the company’s pricing model appropriate?
If it is very difficult to reach this point in a given area, then everyone is right to think about whether it is worth continuing that production.
The calculation of the break-even point helps to do this.
If we calculate this broken down by product, we get answers to the following questions:
- How profitable is the product?
- Is it worth it to deal with this product, or are we better off with someone else?
- Is there a chance to reach at least one break-even, and if so, at what time of year is it expected?
- Which product should the company focus on in the next period?
The steps of calculating the break-even
The calculation of the break-even point will come twice in the life of a business (during a year). The company makes a profit between the two points and a loss above and below it. In the first phase, your sales profit is not yet enough to extract the fixed cost present each month. Above it, the profit on the product is not enough to cover the increased variable costs of surplus production.
As the break-even point shows how much to produce and sell in order for the balance to be positive, both fixed and variable costs need to be considered.
Variable cost eg:
- hourly wage
- shipping cost
- cost of raw material
- salesmen’s performance pay
Fixed cost eg:
- wages of administrative workers
- site maintenance fee
- basic service fee (which is invoiced by the service provider even if we did not use the service)
Of course, not all companies have the same structure. A company set up entirely for physical production will have much higher fixed costs than an online service provider.
Determination of costs
As you can see in the picture, the higher the volume of production and sales, the more the fixed cost is dwarfed relative to the total. This makes the activity more and more cost-effective.
To determine the break-even point, consider both fixed and variable costs (or band-varying costs), otherwise you could easily have problems maintaining your liquidity.
It is important to look at the costs for the same period for easier comparability. This usually appears to be annualized in the calculations. This is because there are fewer distortion factors. These can be:
- items to be paid once a year and several times a year,
- possible downtime
- the sales process (what if the revenue does not arrive in the same month as the cost of production occurred)
Obviously, if you don’t have such a bias, you can even count on a monthly basis.
Of course, in addition to knowing the costs, the price of the product is also an important factor. This makes a break even easier to achieve with a well-chosen pricing strategy.
Consideration of the selling price in determining the break-even point
The product of the selling price and the number of units gives the sales revenue of a company. Don’t confuse it with profit, that’s not it yet!
As you can see in the picture of costs, sales are not a fixed and straight line. The more you want to sell, the more you may find that you need to give a volume discount.
Thus, as your sales increase, your disposable income decreases, but your variable costs increase. Because of this, the company’s production will move in the gray background section.
Obviously, you can calculate the break-even point for each market segment, so you can easily see wether you selling to certain target markets at a loss.
If you don’t have a target market where there is a big difference in selling prices, you can count on the following:
- Your own average price
- Average price for a given level of production: this may be relevant if your banded costs are high or if production costs increase significantly after a certain level
- Average market price: for this you are almost fixed that you will be able to sell the product. The question is, is it worth it to you.
Calculation of the break-even point
To calculate the coverage point, let’s assume that Sample Ltd. Is now a “stuff” specialist. It produces nothing but this.
As the formula in the first picture says:
Margin = Fixed cost / (Selling price – Variable cost)
The sales price variable cost is nothing more than the profit made on 1 product.
Determining the coverage point with numbers:
Selling price: 1,500 HUF / stuff
Price of raw material: 450 HUF / stuff
Labor cost for the production of 1 stuff per 1 product: 500 HUF / stuff
The profit of Sample Ltd per stuff is thus: 1500- (450 + 500) = 550 HUF
Gross margin: HUF 550 / HUF 1,500 = 36%
In order to reach the break-even point and actually generate a profit above it, Sample Ltd. needs to know how many stuffs it has to sell to extract the fixed costs.
Site maintenance: HUF 3,600,000 / year
Salary of clerical workers: HUF 14,000,000 / year
Insurances: HUF 2,000,000 / year
Total fixed cost: HUF 19,600,000 / year
In order for the company to reach the break-even point in this simplified example, it is necessary to produce 19.6 M / 36% = HUF 54.4 million.
To do this, you have to sell HUF 54.4 million / HUF 1,500 = 36,267 pieces of stuff per year.
All you have to do to decide whether to continue or switch to “thing” production is to see that
- is there such a demand for stuff,
- whether there is such a large production capacity.
Of course, you can also change your pricing. With a price increase, your costs will obviously remain, but you will reach the break-even point sooner. Changing pricing isn’t always easy, but it’s the most common way to go.
This only gives the break-even point. Keep in mind that a business that permanently makes a profit close to 0 may sooner or later pull down the blinds.
Use the break-even point calculation to see
- which product is the most or least profitable for you
- for which month of the year, on average, the tipping point from which the road leads upwards is expected (you can use this number in later planning).
Don’t forget to plan the period until you reach the break-even point! In vain would you be very profitable by the end of the year if you go bankrupt by half a year.
Break-even is the point in the economy where costs and expenses are the same, so a business produces neither a loss nor a profit.
- How do you track your own profitability?
- Based on the above, what is your profitability?
- Where is your break-even point? What time of year do you usually reach this time of year?
Contact us to plan your liquidity to reach and exceed your break-even point. We will then find you the tool with which you can accomplish this most effectively.