Break-Even Analysis: Formula and Calculation

The firm invests $200,000 in fixed costs, including building a factory and buying machines for manufacturing. Fixed costs (like office space, server maintenance, and employee salaries) total $15,000 per month, and the variable costs per subscription (customer support and software updates) come out to $10 per unit. The main thing to understand in managerial accounting is the difference between revenues and profits. Since the expenses are greater than the revenues, these products great a loss—not a profit. Consider the following example in which an investor pays a $10 premium for a stock call option, and the strike price is $100. The breakeven point would equal the $10 premium plus the $100 strike price, or $110.

Importance of Break-Even Point Analysis

First we need to calculate the break-even point per unit, so we will divide the $500,000 of fixed costs by the $200 contribution margin per unit ($500 – $300). While the breakeven point is a valuable tool for decision-making, it has several limitations. One major downside is its reliance on the assumption that costs can be neatly divided into fixed and variable categories. For example, semi-variable costs, which have both fixed and variable components, can complicate the accuracy of the breakeven calculation which then changes the breakeven point in units. In corporate accounting, the breakeven point (BEP) is the moment a company’s operations stop being unprofitable and starts to earn a profit. The breakeven point is the production level at which total revenues for a product equal total expenses.

While the breakeven point focuses on financial metrics, successful business decisions also require a holistic view that looks outside the number. For example, it may just not be feasible to sell 10,000 units given the current market for the example above. A gross break-even point is often not entirely correct for figuring out exactly where you would break even on a trade, investment, or project. This is because taxes, fees, and other charges are often involved that must be taken into account.

Limitations of break-even analysis

1. Once the startup exceeds this number, every additional subscription sold contributes straight to profit.
2. In general, the break-even price for an options contract will be the strike price plus the cost of the premium.
3. Reaching your break-even point is one of the first major milestones for any successful business.
4. Generally, to calculate the breakeven point in business, fixed costs are divided by the gross profit margin.
5. For example, you could decrease the required number of subscriptions to break even by reducing the variable costs (like using AI customer service).

The formula for calculating the break-even point (BEP) involves taking the total fixed costs and dividing the amount by the contribution margin per unit. Break-even analysis helps businesses choose pricing strategies, and manage costs and operations. In stock and options trading, break-even analysis helps determine the minimum price movements required to cover trading costs and make a profit. Traders can use break-even analysis to set realistic profit targets, manage risk, and make informed trading decisions. The contribution margin represents the revenue required to cover a business’ fixed costs and contribute to its profit. With the contribution margin calculation, a business can determine the break-even point and where it can begin earning a profit.

Ask Any Financial Question

Meanwhile, the breakeven point in options trading occurs when the market price of an underlying asset reaches the level at which a buyer will not incur a loss. The break-even point formula is calculated by dividing the total fixed costs of production by the price per unit less the variable costs to produce the product. The breakeven formula for a business provides a dollar figure that is needed to break even. This can be converted into units by calculating the contribution margin (unit sale price less variable costs). Dividing the fixed costs by the contribution margin will reveal how many units are needed to break even. If the company can increase its contribution margin per unit to $8 (by perhaps lowering its per unit variable cost), it only needs to sell 8,750 ($70,000 / $8) to break even.

Let’s take a look at a few of them as well as an example of how to calculate break-even point. The break-even point can be affected by a number of factors, including changes in fixed and variable costs, price, and sales volume. Calculating breakeven points can be used when talking about a business or with traders in the market when they consider recouping losses or some initial outlay. Options traders also use the technique to figure out what price level the underlying price must be for a trade so that it expires in the money.

Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. If a company has reached its break-even point, the company is operating at neither a net loss nor a net gain (i.e. “broken even”). Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass 4 factors influencing local government financial decisions the CPA exam, and start their career.

Otherwise, the business will need to wind-down since the current business model is not sustainable. My Accounting Course  is a world-class dividends in arrears educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. It is only useful for determining whether a company is making a profit or not at a given point in time.