In simple words, the break-even point can be defined as a point where total costs (expenses) and total sales (revenue) are equal. Break-even point can be described as a point where there is no net profit or loss. The firm just “breaks even.” Any company which wants to make an abnormal profit desires to have a break-even point.
Break-even point is the number of units (N) produced which make zero profit.
Revenue – Total costs = 0
Total costs = Variable costs * N + Fixed costs
Revenue = Price per unit * N
Price per unit * N – (Variable costs * N + Fixed costs) = 0
So, break-even point (N) is equal
N = Fixed costs / (Price per unit – Variable costs)
Break-even analysis is the study of how the profit is influenced and determined by sales volume, price & costs. Hence Break-even analysis is also called as Cost-Volume-Profit relationship.
Moreover, such analysis facilitates the managers with a quantity which can be used to evaluate the future demand.
The total cost of the product comprises of Variable cost and Fixed cost.
Costs, which vary with the volume of production, are called variable cost. e.g. Raw material, packing materials, power and fuel, Interest on working capital.
Costs, which do not vary with the volume of production, within a relevant range or level of capacity, are called fixed costs. e.g. Salary, Labor Cost, Machinery, Land, Building etc.
Marginal Cost: The cost incurred in producing an additional unit of product is termed as marginal costing. While working out the marginal costing only variable costs are recorded.
eg. if you have produced 1000 units and now you have decided to produce another 100 units, then the cost require to produce the additional 100 units is a marginal cost
Marginal (Variable cost) cost when deducted from sales, gives the figure called Contribution which is to meet the fixed cost first and then to earn a profit. The philosophy of marginal costing is that sales revenue should meet first the variable cost, and contribute towards fixed cost before the enterprise begins to earn the profit.
So, the equation goes as follows:
Sales – Variable Cost = Contribution
Contribution – Fixed Cost = Profit OR
Sales – Variable Cost – Fixed Cost = Profit
Contribution = Fixed Cost + Profit.
Contribution & Break-Even Point::
The difference between the sale price and variable cost is called Contribution. The contribution helps a unit to recover its fixed cost. The level of production at which the contribution recovers entire fixed cost is called break-even point.
If Contribution is greater than the Fixed Cost then the company is in profit &
If Contribution is less than the Fixed Cost then the company is in a loss.
For example, if fixed cost is Rs. 6000, the sale price is Rs. 12 / unit and variable cost is Rs. 6 / unit.
The formula for finding out BEP is
Break-even Point = Fixed Cost / Sale Price – Variable Cost Or
Break-even Point = Fixed Cost / Contribution
6000/ 12-6 = 6000/6 = 1000 units
Break-even sales will be 1000 units * Rs. 12 = Rs. 12,000/-
Any production carried on beyond this level would fetch profit for the Unit.