Almost all businesses might arrive at a certain place where they might need to calculate the break-even point. Of course, the break-even point is delicate in a business that requires balance. Nevertheless, the business usually agrees on a break-even analysis to gather crucial insight and determine fixed and variable costs.
Different aspects of the finances are considered while building the profit and loss statement with accurate entries. The break-even point refers to the balance between revenue and cost. The break-even point is a serious condition for the business where the company needs to pause and decide on the path ahead.
The company will have to ask themselves several complex questions to understand the gravity of the situation. First, the company needs to look inwards and calculate all costs from top to bottom and the cost setting of each item. If the material cost is too high, the cost of the product also increases and vice versa. Hence, the business must ask the right questions.
Different Components Used In The Break-Even Point Formula
Before diving into the formulas used in determining the break-even point, we must clearly understand the different variables or components. These components are also measured from different aspects of business finances. So let us look at the components relevant to the formulas we have explained below.
The contribution margin is what you get from deducting the variable cost per unit from the selling price of the product. By subtracting the material and labor cost from the actual selling cost of a product, you will get the contribution margin. This contribution margin is used to cover the fixed cost. Any amount left after all this will be counted under net profit.
Contribution Margin Ratio
The contribution margin ratio is a percentage rather than a definite figure. Therefore, to measure the contribution margin ratio, you must first determine the contribution margin. Then, the value of the contribution margin is subtracted from the fixed cost to get the ratio. Once you have the contribution margin ratio, the whole process of break-even becomes much more efficient.
As the name suggests, fixed costs are rarely affected by the change. Fixed cost includes rents, production facility, storefront, and other costs that do not fluctuate in small intervals. It also includes additional services and employment cost that has been added on the way. Although the business has certain expenses fixed at the start of each financial cycle, this cost remains the same, more or less, occasionally increasing.
The break-even point is reached when your fixed and variable cost equals the sales cost. At this point, the company’s net profit is supposed to be 0. If the figure is higher than 0, the additional amount is considered the net profit, and a negative value would determine the exact loss amount.
The Intimate Process Of Break-Even Point Calculation Using Two Different Formulas
So, it is understandable that the business needs to stay clear of the break-even point by measuring it. There are different formulas to help the business determine the break-even point. We will be talking about two distinct approaches in this article. For the first one, you will be needed to consider the sold goods unit, and another one is based on the monetary sales point.
In the first case, the business must derive a fixed cost and revenue separately. Then, once they have the figures, they need to divide the fixed cost by the revenue. The fixed cost stands for the goods and material prices that do not change easily. The revenue is the selling price of the product. Finally, the variable cost per unit is deducted from the revenue to calculate the break-even point.
(Revenue + Variable Cost Per Unit) ÷ Fixed Cost = Break-Even Point
The business will first need to determine the Contribution Margin for the second method. This contribution margin is derived from subtracting the variable cost from the product cost. Then, this contribution margin is divided by the fixed cost to bring out the break-even point.
Fixed Cost ÷ Contribution Margin = Break-Even Point
By analyzing the break-even point, the business can plan its future. If they remain stagnant at the break-even point, the company is not earning any profit. Hence, the company needs to increase its sale or lower its fixed cost. However, as you approach business growth, it needs frequent changes and a realistic outlook.