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Break Even Point
Break-even Point (BEP) is the point where expenses and revenues are equal or same.
At this point, there is no profit or loss. This is the point where the company can
say it has "broken-even" meaning that it has recovered all costs incurred though
not yet started making profits. This is one of the simplest forms of analyzing the
relationship between revenues and expenses and consequently profits.
Break-even point can be computed in numbers (units) or amount (dollars, etc). The
formula to compute break-even point is:
The formula to express break-even point in numbers is:
Fixed costs
Contribution margin per unit
Contribution margin per unit = Sale price per unit – Variable costs per unit
The formula to express break-even point in sales dollars is:
Fixed costs
PV ratio
PV ratio = Contribution / Sales * 100
Contribution margin per unit
Contribution margin per unit = Sale price per unit – Variable costs per unit
The formula to express break-even point in sales dollars is:
Fixed costs
PV ratio
PV ratio = Contribution / Sales * 100
The formula is very useful to project sales and profits for the company and to direct
and focus attention to achieve certain profitability. It provides information to
the management to understand when the company would achieve break-even point at
various selling price points and acts as a factor in determining sale price of products.
One of the most important prerequisite to compute break-even point is the segregation
of costs into fixed and variable. Fixed costs are costs that remain constant or
fixed up to a certain level of activity. Irrespective of the level of activity or
production/sales, these costs remain fixed. Examples of fixed costs include salaries,
rent and occupancy costs, depreciation, insurance, etc. Variable expenses are the
ones that vary directly in proportion to sales. As sales rise, so do variable expenses
and vice-versa. If there are no sales, these expenses need not be incurred at all.
Examples of variable expenses include direct materials, direct labor, consumables,
supplies, etc.
Example:
X company is engaged in the manufacture of carpets. Each carpet requires $20 materials,
$15 labor and $5 other supplies. The company has a fixed cost of $175,000 per year.
Each carpet sells for $75 in the market. Compute the break-even point in sales dollars
and number of carpets.
Break-even point in sales dollars:
Fixed costs
PV Ratio
$175,000
46.67%
$375,000
Break-even point in sales dollars:
Fixed costs
PV Ratio
$175,000
46.67%
$375,000
| PV ratio | = | Contribution / Sales |
| = | $35 / $75 | |
| = | 46.67% |
| Contribution | = | Sales – Variable expenses |
| = | $75 – ($20 + $15 + $5) | |
| = | $35 |
Break-even point in number of carpets:
Fixed costs
Contribution per unit
$175,000
$35
5,000 carpets
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