What is the break-even point? How to calculate the break-even point and examples

In the field of business and finance, enterprises must determine the break-even point to minimize the risk of loss. Understanding how to calculate the break-even point is a solution to help managers make production and business decisions, determine profitability and effectively control risks. Let's learn about this concept with 1C Vietnam through the article below.

1. What is the break-even point?

The break-even point (BEP) is the point at which total revenue equals total costs incurred by a business. The break-even point represents the balance between costs and revenue. At the break-even point, the business neither makes a profit nor suffers a loss.

2. Common Break-Even Point Classification

Based on cost factors, there are 2 types of break-even points commonly used in business, including:

• Economic break-even point (break-even point without interest): Is the point where sales revenue is equal to total production and business costs (fixed costs and variable costs). At economic BEP, the company's profit before interest and tax is 0.
• Financial break-even point (break-even point after calculating interest): Is the point where sales revenue is equal to total costs (including interest during the period). At financial BEP, the company's pre-tax profit is 0.

BEP is an important factor, always determined by the administrator before making a business decision. However, depending on the business characteristics and goals of each enterprise, the type of break-even point as well as the appropriate way to calculate the break-even point should be chosen.

3. What does break-even point mean?

The break-even point plays an important role in helping businesses determine the number of products or sales revenue they need to achieve to avoid losses. In addition, this index also helps managers plan finances, adjust selling prices and control costs effectively.

The break-even point is used for many business purposes, including:

• Evaluating business efficiency: The break-even point reflects the level of business efficiency of a business. The larger the number of products needed to sell to reach the break-even point, the more it proves that the business has an inefficient cost structure or the product unit price is too low.
• Deciding on product/service selling price: Calculating the break-even point BEP helps businesses determine the appropriate product selling price to avoid losses.
• Planning and Forecasting: The break-even point helps businesses determine how many products they need to sell to achieve their desired profit. At the same time, the break-even point also allows businesses to assess business risks.
• Investing: The break-even point is an important tool for investors to assess the level of risk involved in investing in a business.
• Cost Management: BEP helps businesses determine the level of costs that need to be controlled to reach the break-even point. From there, businesses can come up with effective cost management solutions and ensure quick profit.

4. How to calculate break-even point in detail

The formula for calculating the break-even point by output is determined as follows:

Break-Even Point (BEP) = FC/(S-VC)

Additionally, the break-even point can be used to calculate break-even revenue, which is determined by the formula:

Break-even revenue = FC/ [(S-VC)/S]

In there:

• BEP (Break-even output): Is the output level needed for the business to break even (unit: product).
• S: Unit selling price of product (unit: VND/product).
• FC (Fixed costs): Are costs that do not change according to consumption output within a certain scale. FC usually includes: Depreciation of fixed assets, property rental, insurance, interest, etc. Interest can be included in fixed financial costs (unit: VND).
• VC (Variable cost per unit of product): Are costs that vary according to the volume of products consumed, including: Direct material costs, direct labor costs, etc. (unit: VND/product).

5. Practical illustration of how to calculate break-even point

To better understand what the break-even point is and how to calculate the break-even point in practice, let's take a look at the example below with 1C Vietnam:

5.1 Example of simple break-even point calculation

Suppose company A is producing and selling pens with fixed costs of 50,000,000 VND, variable costs of 50,000 VND, and the selling price of each pen is 100,000 VND/product. Determine the number of pens that company A needs to sell to reach the break-even point.

We have the formula for calculating the break-even point as follows:

Break-even point = Fixed costs / (Product selling price – Variable costs per product).

= 50,000,000 / (100,000 – 50,000)

= 1,000,000.

5.2 Calculating the break-even point for multiple products

A business produces and sells two products A and B. We have the following information:

• Monthly fixed cost: 100,000,000 VND.
• Variable cost of product A: 50,000 VND/product.
• Product A selling price: 120,000 VND/product.
• Variable cost of product B: 70,000 VND/product.
• Product B selling price: 100,000 VND/product.
• Sales percentage of 2 products A, B: 30% and 70%.

First, we need to calculate the net profit for each product by subtracting the variable cost from the unit selling price:

• Net profit of product A = 120,000 VND - 50,000 VND = 50,000 VND
• Net profit of product B = 100,000 VND - 70,000 VND = 30,000 VND

Based on the calculated results, we determine the weight of net profit of each product as a percentage of sales revenue:

• Net profit weight for product A: 50,000 VND x 30% = 15,000
• Net profit weight for product B: 30,000 VND x 70% = 21,000

Finally, the break-even point calculation for the two products will be represented as follows:

BEP = Total Fixed Cost / (Net Profit Weight of Product A + Net Profit Weight of Product B)

= 100,000,000 VND / (15,000 + 21,000)

= 2,778 (products)

Thus, the business needs to sell a total of about 2,778 units of products A and B to break even. The quantity of each product depends on the expected sales ratio (30% product A and 70% product B).

6. Advantages of break-even analysis in the field of financial investment

Break-even analysis helps businesses plan their budgets, manage costs, and develop appropriate pricing strategies to achieve the goal of maximizing profits.

There are 3 methods of break-even analysis in the investment field, including:

• Equation method

Revenue = Variable Cost + Fixed Cost (At BEP, profit is 0).

BEP = Total fixed costs / (Product selling price - unit variable costs).

Break-even revenue = Break-even output x Product selling price.

• Contribution margin method

Break-even output = Total fixed costs/Unit contribution margin.

Break-even revenue = Total fixed costs/Contribution margin ratio

• Graphical method: At the Oxy coordinate axis, Ox is product output, Oy is total cost. At this time, total cost = Variable cost x Output.

Revenue = Output x Unit selling price. Where, the intersection point of revenue and cost is the break-even point.

In there:

• Fixed costs are fixed costs such as: infrastructure, machinery, research costs, training, etc.).
• Variable costs are variable costs such as: raw materials, electricity and water for production and business, packaging, commission fees, etc.
• Contribution cost = Selling price - Variable cost.

It can be seen that the break-even point is an important number that any manager needs to know clearly to monitor the profit of each product and determine sales to avoid losses and start making profits.

In addition, break-even analysis helps businesses predict factors that affect revenue if selling prices, sales volume or costs change. From there, businesses will have appropriate production and business plans, as well as make decisions on investing in fixed assets to take advantage of business leverage.

7. Points to note when conducting break-even analysis

Typically, assumptions are used in break-even analysis, which can cause difficulties for both managers and businesses. These difficulties include:

• Assuming the selling price remains constant at all output levels: This is not true in practice, when the product sales reach a certain level, the selling price will also change based on the law of supply and demand.
• Break-even analysis is difficult to apply in the context of businesses selling many products because of the difference in selling price and variable costs of each product. However, in reality, businesses often produce and sell many different types of products.
• Assuming the same production and sales volume, in reality, businesses always have to deal with inventory.
• When analyzing the break-even point, businesses do not pay attention to the time value of money, so the results will be different in the case of high inflation.

In general, the break-even point is an indispensable factor in the financial analysis of each enterprise. Analyzing and understanding how to calculate the break-even point will help managers make decisions in choosing the structure between fixed costs and variable costs, in order to maximize the enterprise's profits. Hopefully, with the sharing of 1C Vietnam, your business can understand and apply it in practice, thereby making effective production and business decisions. If you have any questions, please contact 1C Vietnam for support.