The Break Even Point (BEP) is a classic approach to determining when you start to earn money. The BEP analysis calculates the production level at which the Total Revenue equals the Total Costs. Follow the next steps to illustrate its application:
Step 1: Establishing the Equation
Total Revenue (TR) equals Total Cost (TC)
TR = TC
Step 2: Defining variables
TR represents the Sales Price Per Unit (SPPU) multiplied by the unknown quantity X, and TC represents the sum of Fixed Costs (FC) plus Variable Costs (VC).
SPPU*X = FC + VC
Step 3: Expanding the equation
Continue on the right side of the equation; hence the Variables Costs are equal to Variable Cost Per Unit (VCPU) multiplied by X.
SPPU*X = FC + VCPU*X
Step 4: Rearranging the equation
Move the Variable Cost Per Unit to the left side while keeping Fixed Costs separate. Subtract the terms accordingly.
SPPU*X - VCPU*X = FC
Step 5: Factoring out X
Extract X by factoring it out on the left side of the equation, leaving Fixed Costs separate.
X*( SPPU - VCPU ) = FC
Step 6: Solving X
Divide Fixed Costs by the Contribution Margin (CM), which represents the difference between Sales Price Per Unit and Variable Cost Per Unit.
X = FC / ( SPPU - VCPU )
X = FC/CM
Result: Break Even Point
The calculated value of X represents the breakeven quantity, indicating the minimum sales level required to cover the fixed costs and start generating revenue.
Example
Consider a scenario where a bakery incurs monthly fixed costs, such as rent, employee payouts, and utilities, totalling $15,500. The bakery sells cakes for $35 per unit, with variable costs per unit, including ingredients and packaging, estimated at $12.
By substituting these values into the formula, we can calculate the breakeven quantity:
X = 15,500 / (35 - 12)
X = 674
The bakery must sell at least 674 cakes to cover its fixed costs. Any sales beyond this point will contribute to revenue. The real challenge lies in surpassing the breakeven point to generate a profit.
While the formula provided is suitable for a single product and pricing scenario, businesses dealing with multiple products or varying Sales Prices per Unit should employ weighted averages and contribution margin calculations to determine the breakeven point accurately.
Calculating the breakeven point is a valuable exercise for businesses, helping them determine the minimum production level required to cover costs and start generating revenue.
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By Juan Campana
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