Simply defined, break-even point refers to the situation where the costs associated with the production of your commodity are equal to the revenue generated. At this juncture, neither profit nor loss has been made. A break-even analysis therefore refers to the investigation of the relationship between costs and revenue generated from sales. It is a compulsory consideration if one is contemplating starting a business, or for those already in operation, how to proceed.
Here is what you need to know about determining it:
Fixed costs (FC): These are the expenses that remain constant through the whole production process. They are independent of the output and include expenditures such as rent, salaries, mortgages and loans.
Variable costs (VC): Expenditures that vary with the volume of output. Unlike fixed costs, these increase with a rise in production and vice versa.
Contribution Margin: It refers to the difference between the revenue generated from sales and the variable costs incurred in the course of production. When dealing with each unit, it measures the revenue the unit has left over (after deducting variable costs) to cover the fixed cost.
Determining the point at which you will break even highly depends on the sales you make, whether for the services you rendered or the product you sold. This is because the contribution margin which is a vital component of the formula depends on a unit’s selling price.
Say you have a business that incurs a fixed cost of KES 500,000 every month. Your product, a pack of noodles, has a variable cost of KES 10 (per unit) and sells at KES 30. The quantity that you require to break even will be 500,000/(30-10), which is 25,000. This means that for your production costs to match your revenue, you will need to have sold 25,000 packets of noodles. The resulting revenue is KES 750,000 i.e. the total income from the packs 25000*30. Any money made beyond this return is a profit.
With the help of other organizational functions such as marketing and sales, achieving this target can be done quicker. The break-even point can be used to find out how long your business would take to reach the point, thus affecting your annual objectives. It will also help you plan on your finances since the period before the break-even is largely characterized by losses and uneven cash flow. Planning ahead is crucial to your business’ survival.