The Break-Even Analysis
What Is Break-even Analysis?
Simply the breakeven point is the point where the resources and effort involved in attempting a
job is equal to the benefits to be derived from that job. Profitability emerges when activities continue after this point. Therefore, calculating the break-even point will be beneficial for the business. That is, when a business is attempted, the initial cost always remains. So this cost cannot be avoided. As a result of the cost incurred, the business will have a certain expectation. On the way to meeting these expectations, there is a point where the cost you bear and the income you earn are equal, and reaching this point quickly is extremely important for the continuity of the business.
How To Calculate Break-Even Point
You rented a shop to sell pens. You pay a monthly rent of €1,000. You buy the pen from the wholesaler for €2. You have decided that the pen can be sold for €4 in your region. In this case, how many pens you sell per month can you cover your expenses?
If we calculate directly with the breakeven point formula
1000 / (4-2) = 500
You have to sell 500 items to cover the monthly operating expenses without making any profit. Here, the amount of 500 pens is the breakeven point for your companySo, Break-Even Point tells us how much product we should be sold to cover all the expenses, Let s find how much revenue we need to have in order to cover all expenses,
Break-even revenue will be= Selling Price x Break-even unit ===> €4 x 500= € 2000 is our break-even s revenue
We are required to examine three states in order to make a decision which product is more profitable;
A- Demand which is given occurred
B- What if Company sell more than demand
C- What if the demand does not occur
The Break-Even analysis also helps us to find the most profitable products among our product range;
For example, you have two products A and B and we want to know which product is more profitable, As we see we are given the demand for each product, which also means how many units of product will be sold,
State A has been demonstrated in the table above, Even though the selling price of A nad Demand is higher than product B, B is still more profitable comparing to A
State B- If the company sells more than it expected, For example, the demand for the company is given however, the company assumes sales will increase by 500 units for each product.
In this case, we need to determine our total profit,
for the product, A total profit will be €185,000
for the product, B total profit will be €490,000 ====> as we see there is a significant change in case of increasing demand by 500 units
State C - Demand does not occur
The Company forecasts the demand will decrease and they might be coerced to work with less capacity; we are asked what product will be more profitable in this condition;
Companies are not working at full capacity, they have time limitation, labor limitation, material limitation, therefore this state is more likely we will encounter within companies
First, we are required to find the contribution of each product
Contribution for A===>Selling Price- Variable Cost =€100-€90=€10 per/unit
Contribution for B===>Selling Price- Variable Cost = €96-€70=€26 per/unit
Break-even for A= Fixed Cost of A / Contribution of A====>€20,000/€10 ==> 2000 units are needed to be sold
Break-even for B= Fixed Cost of B / Contribution of B====>€30,000/€26==~>1,154 units are needed to be sold
As a result, The Contribution of B is higher than the contribution of A and, we also can deduce from Break-Even analysis product B is more profitable, therefore if the company wors limited capacity the company will use its capacity to produce B if any capacity left, the company will produce A the remaining of its capacity