The importance of breaking even in business finance

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Profits aside, the first worry of any business is to be able to break even. Break-even is the volume of sales that is needed to cover the expenses incurred in production.

This is termed the break-even point. For this, you need to work out the contribution of each unit sold that pays for the fixed and indirect costs of the business.

Of course, knowing your break-even for operations, production, sales and investment payback not only helps in pricing, debt service and other functions of operating your business but also acts as an important benchmark for long-term business planning. Not only this, break-even determines the viability of your business and is also an important reference for people financially associated with it.

Understanding break-even

If your factory produces metal rings and the production cost for each ring comes to $5, which include material, labor and other direct costs, your break-even point for producing 1,000 rings will be $5,000 or $5 per ring. This cost is not inclusive of indirect expenses, such as your overhead costs, rent of the premises, insurance, phones, etc., that may amount to $10,000, that is, $10 per ring for 1,000 rings.

This means that your break-even point to produce 1,000 metal rings comes to $15,000, that is, $15 per ring. However, this still does not include your unpaid start-up debt. For it to be paid off in two years, you will need to add $10 to your metal ring, making it $25 per ring and sell 2,000 of them in two years. Once this is achieved, your break-even point again drops to $15 per ring. This is how the break-even point is achieved.

Determining your break-even point

Determining the break-even point is not as simple as illustrated in the example mentioned above. This is because, in addition to fixed costs, several variable costs keep fluctuating. For example, costs of materials, production, labor and shipping increase with the increase in sales and vice versa.

In contrast, expenses such as rent, etc. remain unchanged and are counted towards fixed costs. Although this expense remains the same irrespective of how many rings you sell, the expense per unit changes with the number of rings sold. For example, a sale of 1,000 rings will help realize a rent cost of $1 per ring and a sale of 2,000 rings, $0.50 per ring.

Working out fixed and variable costs per unit of the estimated sales of total units will help in determining your break-even point and your pricing needs.

This estimation can be easily achieved by using a break-even calculator. Since the break-even point is the number of units that must be sold to make a profit of zero, this calculator will help you determine the number of units required to break even. All you need to do is to enter your fixed and variable costs, the selling price and the number of units likely to be sold and click on ‘calculate’. And presto! You get the results in a jiffy!

Break-even analysis

Your efforts to introduce a new product in the market can only succeed if you have a full understanding of the total costs involved and what prices they can charge. Failure to do so may result in your business collapsing. However, taking recourse to break-even analysis will help in accurately determining the profitability of your idea. Not only this, but this analysis will also help in evaluating every product that you offer.

While using the break-even analysis, you need to have a fair idea of fixed and variable costs, as also of semi-variable costs that fluctuate up or down. Once you deduct all these costs, you will be left with some amount of profit. This profit is then divided into ‘fixed costs’ to derive the number of units that need to be sold to break even.

For an accurate break-even analysis, you will need to examine and study costs and prices in your business carefully. This includes the price you can charge for the product or service, as also the total costs of product or service that are delivered to the final customer, deducting or adding all miscellaneous expenses of operating your business.

Conclusion

Determining the break-even point through break-even analysis is a safe and practical way of gauging the viability of successfully marketing your product or service. It is a pointer that helps you decide whether to invest your time and money in your product or discontinue it.

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