Break-even is a term used in business and economics to describe a situation where the cost of the business is equal to the revenue received.
Break-even analysis is important in business and economics to determine profitability, the best unit price for a product or service and to develop company strategy in line with profitability. The users of the information provided by a break-even analysis are investors, managers and corporate strategists.
Supposing you have set up a business and it cost you $X. After a period of time you find out that you have received sales worth $X; which is the same amount of money you used to set up the business. This point in business where there isn’t any net loss or net gain is referred to as the break-even point.
The break-even point is usually measured in terms of sales – that is, how much you need to have sold before you recoup your investment. To calculate this value (X), we know that:
_ Total Revenue = Total Cost
but Total Revenue = Product Price (P) x Sales (X)
and Total Cost = Total Fixed Costs TFC + (the variable cost V x Sales X)
so P x X = TFC + (V x X)
_ P – (V x X) = TFC / X
Therefore, break-even point
_ X = TFC/ P – V
If it costs $1 to buy an orange that you resell for $2 and the cost of business is $50 a day then you need to sell 50 oranges a day just to keep the business running. Anything below 50 oranges means you are making a loss and anything above that means that you are making a profit.
In general, the total cost can be divided into fixed and variable. The fixed costs represent costs that do not change regardless of the amount of sales the business makes or lack thereof. These costs do not change in the short term but have the ability to change in the long run. Examples of these costs are; rent charges, land and rates, marketing and advertisement costs, administration costs and depreciation.
The variable costs are costs that change depending on the amount of products produced and sold. Examples of variable costs include labor costs, cost of production materials and fuel costs and can be separated into two types: direct and indirect variable costs. Direct variable costs are those that have been expressly incurred in the production while indirect costs have not been expressly incurred in the production process.
Related topics: Accounting basics