If you are commencing a business with a novel idea you are eventually bound to determine the quantity of sales at which you will make a profit. Similarly, some stakeholders might want to establish a time period where they will be able to draw a good amount of salary. All these questions can be answered with a simple yet valuable concept known as the breakeven point or breakeven analysis.
It is essential for you to understand that predicting an accurate amount of profits or sales is practically unattainable due to an organizations several products that have varying degrees of profitability. Moreover, a company also has numerous customers who have different demands when it comes to the products or services being provided and the price being offered.
So what exactly is this concept and how can it be utilized to obtain useful insight as to how profits are modified with an increase or decrease in sales. Break-even analysis can be defined as the revenues that are required to reach an organizations sum of variable and fixed expenses throughout a specified period. These proceeds can be stated in units (such as time of service), or in dollars (currencies).
In short, it is a procedure of learning the connection amongst sales revenue, fixed cost and variable cost to establish the extent of operation where all the costs will be equivalent to the revenue earned for that particular product. It is the point at which there is no profit no loss. This is an imperative method employed in profit planning and executive decision making. In order to analyze, graphical charts or formulas are used which indicate estimated profit or loss at dissimilar levels of sales within a limited array.
Calculation of breakeven point can be done using multiple methods, some of which are mentioned below:
The breakeven point method when used is calculated by dividing the sum of fixed costs of production by the price apiece minus the variable costs to manufacture the item.
Breakeven point in units = Fixed Costs / (Sales Price per unit – Variable Cost per unit)
This is where the concept of contribution margin per unit comes in. It can be defined as the price per unit less the variable costs of manufactured goods. Looking at this description, we can simply rearticulate the equation.
Breakeven point in units= Fixed Costs/ contribution margin per unit
It will give you the sum of quantity of units that should be traded in order to produce sufficient revenues to envelop all of its operating costs. Similarly, this concept can further be taken and translated into dollars. The breakeven method in sales dollars is computed as follows:
Breakeven point in dollars= Sales price per unit x Breakeven point in units
It will provide you a complete dollar sum for sales that we must accomplish to come to zero profit and zero loss. Breakeven point can be expanded to determine the number of units that must be vended to produce profit.
# Of units to get desired profit = (Desired Profit in Dollars/Contribution margin per unit) + Breakeven number of units