What is Break Even Analysis? How to calculate it for a single product produced by a company? Importance of knowing Break Even Point.

Break Even analysis is a method that helps a company to determine whether the future product will be profitable or not and how many items have to be sold to have neither loss nor profit(BEP). It is the relation between the fixed costs, Variable costs, and revenue of the products.

An important responsibility of the engineer is to choose a manufacturing process that makes the required quality product at a lower cost possible. To fulfill both conditions, one would have to do a break-even analysis.

Important terms used for calculating BEA

·         Fix costs (f.c.):- These are the initial investments. This includes investment in equipment cost, rent, labor cost tool cost, etc which are required to process the product. This cost would be constant and does not vary with the quantity produced.

·         Variable cost (v.c):- Variable costs are the cost that will vary with the quantity produced. This cost includes the cost of raw materials, energy consumed, etc. The higher the number of items higher will be the variable cost.

·         Total Revenue (TR):- This is the amount for total sales of the product. It can be calculated by multiplying the total number of products by the prices of each product.

i.e. TR= total number of product/goods sold * average price of the product

·         Total cost (TC):- It is the total expenditure on the product to be produced.

  contribution margin:-It is also called gross margin. Basically, it indicates how a particular product is going to contribute to the overall profit of the company. It is calculated by sales price per unit minus variable cost.

Note

1.     1. At BEP there will be no loss, no profit

2.     2. As the number of production increases, the cost per unit produced decreases.

This is the fact that the fixed cost associated with production remains constant. i.e. From the same fixed cost equipment or other parameters, small or large quantity can be produced. Hence, overall cost decreases based on variable cost only.

The relation shows the basic formula of the Break even analysis

TC=f.c+v.c*n

Where,

n=quantity produced/sold

f.c=fixed costs

v.c=Variable costs

t.c=Total cost

Also, we know that

SP=cp+p

    =TC+p

    =(fc+vc*n)+P                                                   [ from above Total cost=fc+nvc)

n*Sp= fc+vc*n+p                         [Total selling price=sp*number of items sold)

nSp-nvc=fc+p

n=(fc+P)/(SP-VC)

n=(fc+P)/contribution              [Contribution is the number of earnings remaining after all direct costs have been subtracted from revenue]

By using this formula we can calculate the breakeven point for a single product produced by a company.

Calculation of BEP

If the engineer has to make a choice between two different processes for manufacturing a good, he/she may first estimate the Fc and VC of the process and then plot the tc graph. Let's understand by examples.

Example1

For better understanding let's assume the fixed cost is given as 30000. Likewise, assume variable cost is 200/unit of product. The company is planning to produce 40 identical products. The company is planning to get a profit of 10000. The selling price is 300per units.

we know the formula, the total cost company has to spend is

TC=fc+vc*n=rs3000+rs100*40=rs7000

So total sales= 300*40=rs12000

Contribution margin (CM)=total sale per unit –variable cost per unit

                                              =300-200=rs100/unit

Still, this 4000 is not the total profit because fixed cost payment still has to pay from the profit.

 From formula

n=  (fc+P)/contribution margin cost

n=(30000+10000)/100  = 400

This means if the company has to sell more than 400 items to gain 10000 profits.

Example2

A shopkeeper sells watches at 500 each. It cost 300 each to make as a variable cost. At the same time, the shopkeeper is paying 1000/month for his shop. His average sell is 10 watches a month.

Now let’s calculate whether he is gaining or losing.

Gross margin=500-300=200

From formula

n=(fc+P)/Gross margin=(1000+0)/200=5

So, the shopkeeper has to sell more than 5 watches to gain profit.

Importance of BEA

·        Pricing:-Break Even point will help to keep the better price of the product. This tool helps for providing the best price to gain maximum profit without loss.

·        Managing all fixed prices:-It helps to analyze all the fixed prices. It helps to review all the fixed prices constantly.

·        Reduce Chances of loss:- As we calculate the BEP, we have a general idea about pricing. We can arrange the process and other parameters accordingly.

·        Overcome competition:- we have all the necessary data to analyze market mood and play safely in the competitive markets.