The threshold of profitability is the situation in which sales revenues cover the fixed costs and variable costs of the company. A necessary condition for calculating the break-even point is the division of the company's costs into fixed (for example, depreciation) and variable (for example, energy used in the production of materials, wages of production workers).
The break-even point can be expressed in quantitative terms (how many units of the product must be sold) or in value terms (what price the company must achieve). At the break-even point, the company does not incur any losses or profits, the financial result is zero. It should be noted here that cash flow is equal to depreciation exactly at the break-even point.
Definition
The break-even point (BBU) can be defined as the point at which total costs (expenses) and total sales (revenues) are equal. Break-even is the option of no net profit or loss. The company is simply unprofitable. Any company that wants to break even must reach TBU. Graphically, this looks like an intersectiontotal cost and total income curves.
Concept
Analysis of the break-even point is the definition of a margin of safety. This is usually done by comparing the amount of revenue to be received with the amount of fixed and variable costs associated with sales or production. In other words, it is a way to calculate when a project will be profitable by equating its total sales revenues to its total expenses. There are several different uses for the equation, but they all involve management cost accounting.
The main thing to understand in management accounting is the difference between revenue and profit. Not all income results in profit for the company. Many products cost more than the revenue they generate. Because the costs exceed the income, these products generate big losses, not profits.
The purpose of the break-even analysis is to calculate the amount of sales that equates income to expenses. There are many different ways to use this concept.
General method
The break-even point is the number of units produced (N) that generate zero profit.
Revenue - Total cost=0.
Total cost=Variable costN + Fixed cost.
Revenue=Unit PriceN.
Unit PriceN - (Variable CostN + Fixed Cost)=0.
So, the sales break-even point (N) is:
N=Fixed cost / (Unit price- Variable costs).
About the break-even point
The origins of the break-even point can be found in the economic concept of the "point of indifference". The calculation of this indicator for the company turns out to be quite simple, but a high-quality tool for managers and managers.
Breaking-even analysis in its simplest form helps to understand the amount of income from the sale of a product or service. This indicator signals the ability to cover the corresponding production costs of a particular product. In addition, TBU is also useful for managers, as the information provided can be used in making important business decisions, such as preparing competitive offers, setting prices, and applying for loans.
Moreover, break-even analysis is a simple tool that determines the minimum number of sales that will include both variable and fixed costs. Such an analysis makes it easier for managers to determine the amount of production that can be used to estimate future demand. In a situation where the TBU is above the expected demand, reflecting losses on the product, the manager can use this information to make various decisions. He could drop the product, improve promotional strategies, or even revise the price of the product to increase demand.
Another important use of the indicator is that TBU helps to recognize the relevance of fixed and variable costs. fixed costsless with more flexible and adapted production and equipment, resulting in a lower TBU value. Therefore, the importance of this indicator for smart business and decision-making is clear.
However, the applicability of the TBU analysis is affected by numerous assumptions and factors that can skew research results.
The most popular calculation formula in physical units
The break-even point is calculated by dividing the total fixed cost (of production) by the unit price minus the variable cost of that unit of product:
TBUnat=PZ / (C - Before), where TBUnat is the break-even point, units;
FC - fixed costs, i.e.;
P - unit price, t.r.;
Before - variable costs in unit cost, t.r.
Formula for Marginal Profit
Since the unit price minus the variable costs of a product is the definition of the margin per unit, it is possible to simply rewrite the equation as follows:
TBUnat=PZ / MP, where MP is marginal profit per unit, t.r.
This formula calculates the total number of units that must be sold in order for the company to generate enough revenue to cover all of its expenses.
Formula for calculating in monetary units
The break-even formula in value units is calculated by multiplying the price of eachunits for these TBU in physical terms.
TBUden=CTBUnat, where TBU is a monetary expression, i.e.;
P – unit price, t.r.;
TBNat- value in natural units, units
This calculation gives us the total unit value of sales that a firm must generate in order to have zero losses and zero profits.
Calculation formula for exceeding breakeven
Now you can take this concept a step further and calculate the total number of units that must be sold to reach a certain level of profitability using the break-even calculator.
First we take the desired amount in units of value and divide it by the marginal profit per unit. We calculate the number of units that we need to sell in order to make a profit without taking into account fixed costs. The formula for calculating the break-even point looks like this:
TBUprib=P / MP + TBUnat, where TBUprib - units of production for profit, units;
P - fixed costs, t.r.;
MP – marginal profit per unit, t.r.;
TBUnat - calculated TBU in physical units, units
Example
Let's look at an example of each of these formulas. The limited liability company is engaged in the production and sale of product A. Management is not sure that the models of product A of the current year will bring profit. To do this, measure the number of units they will have to produce and sell to cover theirexpenses and earn 500 thousand rubles. Here are the production statistics (raw data):
- total fixed costs: 500 thousand rubles;
- variable costs in unit cost: 300 rubles;
- sale price per unit: 500 rubles;
- desired profit: 200 thousand rubles.
First, we need to calculate the break-even point per unit, so we divide the fixed cost of 500,000 rubles by the contribution margin of 200 rubles per unit (500-300 rubles):
500,000 / (500 - 300)=2,500 units.
As you can see, the organization will have to sell at least 2,500 units to cover fixed and variable costs. Anything sold after the 2,500 unit mark will go straight to profit as the fixed costs are already covered. In such a situation, we can talk about a profitable business.
Then convert the number of units to total sales by multiplying 2,500 units by the total selling price for each unit of RUB 500.
2,500 units500=1,250,000 rubles.
Now the management of the LLC may determine that the company must sell at least 2,500 units, or the equivalent of sales may be 1,250,000 rubles, before any profit is made.
Companies can also take it one step further and use the break-even calculator to calculate the total number of units that must be produced to reach its $200,000 profitability goal by dividing the desired $200,000 profit by the contribution margin, athen adding up the total number of break-even units:
200,000 / (500 - 300) + 2,500=3,500 units.
Analysis
There are many different ways to use the break-even concept of an enterprise. Managers must clearly understand the required level of sales and how close it is to fixed and variable costs. That is why management is constantly trying to change the elements in the formulas to reduce the number of units needed for production and sales volumes and increase profitability.
For example, if management decides to increase the selling price of product A in our example by 50 rubles, then this will have a drastic effect on the number of units needed to make a profit. It is possible to change the variable costs for each unit, adding more automation to the production process. Lower variable costs equal more profit per unit and reduce the total quantity to be produced. The introduction of outsourcing can also change the cost structure.
Margin of safety
When considering how the profitability of a business is calculated, the concept of a margin of safety arises. It is understood as the difference between the number of units needed to achieve a profit target and the number of units that must be sold to cover costs. In our example, the firm had to produce and sell 2,500 units to cover its costs. It is necessary to produce 3,500 units to reach the set targets. This spread of 1,000units is a margin of safety. The amount of sales that a company can afford to lose while still covering its costs.
It's also important to remember that all of these models reflect non-cash costs such as depreciation. A more advanced break-even calculator would subtract non-cash costs from fixed costs to calculate the level of cash flow at the break-even point.
Conclusion
Thus, for the development of modern business, management always needs to understand the level of sales of their products at which the company will not incur losses. But the company also does not receive profit when this level is reached. Such a concept of break-even is used to solve many management issues regarding the expansion of production, the introduction of innovations, and organizational changes. The higher the sales volume with the indicator under study, the more profitable and cost-effective the business is.
