What is Break-Even Point In Accounting?
Break Even Point in Accounting refers to the point or activity level at which volume of sales or revenue exactly equals total expenses. In other words, the breakeven point is that the level of activity at which there is neither a profit nor loss and the total cost and total revenue of business are equal.
It is that level of business activity where the sales are just sufficient enough to meet the total cost which includes both Fixed and Variable Cost. Also, the Breakeven point acts as an important level for a business to attain before it can actually make a profit. The accounting break-even point can be computed in different ways.
Break-Even Point Formula
Another formula to calculate Break-Even Point in Accounting
Importance of Break-Even Point in Accounting
In order to understand the importance behind the Break-Even Point in Accounting, it is of paramount importance to understand the classification of Costs. Broadly speaking Cost is classified as either Fixed Cost or Variable Cost.
- Fixed Cost is one which is independent of the level of sales and is of a fixed nature. Some of the popular examples include Rent, Insurance, etc.
- Variable Cost is one which is directly linked to the level of sales. Examples include commissions etc.
Segregation of cost into “Variable Cost” and “Fixed Cost” and their relationship with Sales and Profit is important in undertaking the Breakeven point Analysis. By segregating the cost into fixed and Variable, a business can ascertain the cost which is sunk in nature (Fixed Cost) and will not be impacted with Sales directly. Secondly once a business can ascertain the proportion of Variable Cost to its Sales, it can implement strategies that can result in Cost Efficiency which again results in better cost management and more profits.
Breakeven Point Analysis helps businesses understand its Cost Structure vis a vis its Sales Revenue and how the same gets affected as Revenue changes. It helps them to determine the break-even point for different sales volume and cost structures. With this information, the management can better understand the overall performance and determine what units it should sell to break even or to reach a certain level of profit.
Let’s understand the Break-Even Analysis in Accounting with the help of an example:
Crave Limited has recently entered into the business of making Table fans. The management of the company is interested in knowing the breakeven point at which there will be no profit/loss. Below are the details pertaining to the cost incurred:
So, first will find out the No. of units sold by Crave limited:
No. of units sold by Crave limited will be:
Now, we need to find out the Variable Cost per Unit
Variable cost per unit will be:
Now we need to find the Contribution per unit i.e = Selling price per unit-Variable Cost per unit
Contribution Margin per unit will be:
Now, at last, will find the Break-Even Point by using its formula = (Fixed Cost/Contribution Margin per unit)
Break-Even Point formula will be:
Thus Crave limited need to sell 1000 units of electric Table fans to break even at the current cost structure. At this break-even point of 1000 units, Crave Limited will succeed in meeting both its Fixed and Variable expenses of the business. Below the break-even point of 1000 units, Crave Limited will make losses on a net basis if the same cost structure exists.
Here it is important to understand that the Fixed Cost (in this case $60000) is constant and doesn’t vary with the level of Sales Revenue generated by Crave Limited. Thus once Crave Limited succeeds in generating Break-Even Point, all Sales over and above that level will lead to profits as the excess of sales over Variable Cost will be a positive value since Fixed Cost has already been fully absorbed by Crave Limited on attaining the Breakeven Sales Level.
- One of the most important and basic benefits of Break-Even Point in accounting is its simplicity of calculation and helping the business determine the number of units to be sold to breakeven i.e. no profit no loss.
- It helps in understanding the cost structure i.e. the proportion of Fixed Cost and Variable Cost. Since Fixed Cost doesn’t change easily, it helps business owners to take measures to control the Variable cost without focusing on the total cost.
- It is very important in forecasting, long-term planning, growth and stability of the business.
- The biggest shortcoming of Break-Even Point in accounting analysis lies in the nature of assumption which holds that fixed cost remains constant and Variable cost varies proportionately with the level of sales which may not be the case in the real-world scenario.
- It assumes costs are either fixed or variable; however, in reality, some costs are semi-fixed in nature. Example Telephone expenses comprise a fixed monthly charge and a variable charge based on the number of calls made.
It is difficult for any business to decide with accuracy its expected level of sales volume. Such decisions are usually based on past estimates and market research regarding the demand for products that are offered by the business. On the other side Business Cost especially the Fixed Cost of business is fixed in nature which in any case can’t be recovered by the business and is sunk in nature. Break-Even Point in accounting helps in bridging this gap by enabling business in determining how much quantity they need to sell to break even i.e. no profit no loss. It is an important management accounting concept which is continuously used by business in not only determining the Breakeven Sales level but also in optimizing its cost. Once a business is able to know its break-even point it can make efforts by either reducing the amount of its fixed cost or by increasing its contribution margin which may be achieved by selling a greater proportion of high contribution margin products.
This has been a guide to what is Break-Even Point in Accounting. Here we discuss accounting break-even analysis along with calculation, formula, advantages, disadvantages and practical examples. Here are the other articles in accounting that you may like –