Every specialist in the financial management of companies and projects understands the significance of the break-even point and its implications for the project’s direction, whether profit or loss, as they meticulously plan and study projects to achieve their ultimate goal of profits. Therefore, we must calculate and compare the production costs with the expected returns at the outset to accurately assess the project’s potential for profit or loss. In addition to determining the amount of product that must be marketed and sold so that the amount of costs incurred by the company to produce the goods is equal to the profits achieved by those goods when sold, this is known as the break-even point, which is an important indicator that must be measured when wanting to invest in a project.
Definition of break-even point
The term break-even point simply refers to the moment at which both ends of the scale are equal. This means that it is the point at which the costs incurred to produce goods equal the revenues generated by those goods when sold, and the product makes neither a profit nor a loss.
Calculating the costs required to produce goods includes two types of expenses. The first are fixed expenses, which do not change with the number of units of goods produced; the second are variable expenses, which change with production. This means that producing 100 pieces becomes more expensive than producing ten pieces, which indicates that higher variable expenses necessarily mean a higher break-even point.
Objectives of break-even point analysis
Accounting experts need to analyze the break-even point between revenues and expenses to achieve the following objectives:
- Determine how many pieces of the product must be sold to cover production costs, whether they are fixed or variable.
- Calculating the margin of safety that controls the investors’ decisions in the project expresses the number of sales required to be achieved to cover the costs of doing business.
- Make appropriate decisions to increase profits and avoid losses.
- After determining the production costs, determine the most appropriate price for the product or commodity after determining the expenses associated with its production.
- This will enable the company manager to allocate appropriate financial resources to maintain the business, such as a budget for employee salaries, purchasing raw materials, and so on.
The importance of calculating the break-even point
It is necessary to calculate break-even points because they are a turning point in the course of business, and are an essential basis for the following steps:
- Establish appropriate pricing for the goods manufactured by the company and ensure that their pricing covers their production costs while achieving a profit margin.
- Determine the type of goods that must be produced for expansion or investment based on knowledge of the details of their fixed and variable costs, linking them to the market, and the percentage of demand and expected return.
- Reduce production costs and eliminate unnecessary expenses in order to raise the product’s profits.
- Verifying the validity of the company’s industrial and marketing performance, as well as identifying the strengths and weaknesses in those aspects, contributes to clearly following up on the established plans.
Break-even point calculation concepts
To be able to reach a break-even point for a product, you must understand the following terms:
- Fixed product costs are expenses incurred by the company without specifying the number of pieces produced, such as the salaries of facility workers and the cost of repairing equipment.
- The variable cost of a product relates directly to the production of the good, such as the costs of purchasing raw materials.
- The unit profit margin is the result of subtracting its variable cost from its price, which means the profit margin for a product whose price is 50 riyals and whose variable cost is 10 riyals is (50-10 = 40 riyals).
- The sales or marketing mix is the term used to describe the company’s strategies for studying the market in order to increase profits.
How do you calculate the break-even point for a single product?
There is a simple equation to determine the break-even point for any individual product (one type of commodity):
- Break-even point = fixed costs ÷ (individual unit price – variable cost per product unit).
- It can also be said that the break-even point = fixed costs over the profit margin for one product.
- To explain this, we will assume that the product cost details are as follows:
| Fixed costs | 250,000 riyals |
| Variable costs | 150 riyals |
| Product price | 700 riyals |
| Breakeven | 454 |
- Based on the data in the table, the point of equality between costs and revenues was calculated by first calculating the profit margin, which is (700 – 150 = 550).
- Then, the equation was applied (250,000 ÷ 550 = approximately 454), meaning you must sell more than 454 pieces of the product to start making profits.
How is the break-even point calculated for more than one product?
As we noted above, the procedures for determining the product break-even point were specific to a project that included producing one type of commodity. How is the break-even point calculated for a project that produces multiple products? Then the following steps are taken:
- We calculate the average cost of the selling mix by multiplying the product’s selling price by the ratio of the selling or marketing mix.
- Extracting the average variable cost of the selling mix equals the variable cost per unit x the selling mix ratio.
- Determine the average profit margin of the selling mix, equal to the average price of the marketing or selling mix—the average variable cost of the marketing mix.
- In the end, the break-even volume of the selling mix is extracted, which is equal to (fixed costs ÷ average marketing mix profit margin).
This is explained below:
| Product Type | Price per piece | Variable cost per piece | Marketing mix ratio for the product |
| Plastic cars | 100 riyals | 15 riyals | 45%. |
| Plastic bottles | 20 riyals | 5 riyals | 5%. |
| Locks for refrigerators | 50 riyals | 10 riyals | 10%. |
| Fixed costs of products | 150,000 riyals | ||
- The average selling price for the selling mix of the three products is as follows:
| Product Type | unit price | Marketing mix | Average selling price of the marketing mix |
| Plastic cars | 100 | 45% | 45 riyals |
| Plastic bottles | 30 | 5% | 1.5 riyals |
| Locks for refrigerators | 50 | 10% | 5 riyals |
| Average selling mix price | 51.5 riyals | ||
- Extracting the average variable cost of the marketing mix
| Product Type | Variable cost per piece | Marketing mix ratio | Average variable cost |
| Plastic cars | 15 | 45% | 6.75 riyals |
| Plastic bottles | 5 | 5% | 0.25 riyals |
| Locks for refrigerators | 10 | 10% | 1 riyal |
| Average cost of the marketing mix | 8 riyals | ||
- Average profit margin for the marketing mix = 51.5 – 8 = 43.5 riyals.
This means that the break-even size of the marketing mix for those products will be (150,000 ÷ 43.5 = approximately 3,448.2 pieces), which indicates that profit will be made after selling 3,449 pieces of the three products.
An example of a break-even point
Let’s assume that we want to calculate the break-even points for a company that produces electric fans using the data in the following table:
| Fixed costs | 300,000 riyals |
| Variable cost per fan | 50 riyals |
| The market price for the fan | 250 riyals |
The break-even point is 300,000 ÷ (250 – 50) = 1,500 fans that must be sold in order for the company to start making profits.
The relationship between the break-even point and the margin of safety
The term margin of safety refers to the difference between actual sales and the sales achieved when the break-even point is reached. It is assumed that there will be an increase in actual sales volume above the break-even point to achieve profits. The greater the margin of safety, the more profits will increase.
This means that if we assume that the break-even sales of fans are 1,500, as in the previous example, and that the actual sales of fans are 2,000, then the margin of safety is the result of subtracting (actual sales volume minus the break-even point) = (2000 minus 1500 = 500). Thus, the company achieves a profit when it sells 500 fans after surpassing the break-even level, allowing it to produce a maximum of 500 additional fans and quickly cover its costs. However, if they fail to compensate, the project will fail.
The margin of safety measure establishes the anticipated percentage of sales decline prior to reaching the break-even point, with the aim of preventing losses and optimizing marketing strategies. Start-up companies use it to choose their path towards more sales and are interested in evaluating it to help them take actions that will quickly achieve profits.
When does the break-even point rise?
As previously mentioned, the costs incurred in producing the product determine its break-even point. Sometimes, the point required to achieve equality between costs and revenues is high, which makes reaching it take some time. This phenomenon occurs due to several factors, including the following:
Increase Sales
This refers to a situation where a product is in greater demand than expected. This implies that to reach the break-even point, sales must cover and recoup additional production costs, a trend that will persist as sales increase.
Increase the production cost.
This means that the product’s price remains stable in the face of an increase in its production cost, whether the increase is due to raising the prices of raw materials or having to pay additional expenses for storing or marketing it, among other things. Adding these costs to the product’s fixed cost further raises the break-even point and delays its reach.
Need to repair equipment.
Suppose there is a disruption in the production process due to equipment damage or breakdown. In this case, the break-even point will rise as repair or replacement costs rise, and the company may stop production due to the malfunction. Having to compensate for all these expenses makes achieving a break-even point increasingly challenging.
Factors that contribute to lowering the break-even point
The lower the break-even point, the faster the company can reach it and achieve profits, contributing to increased investments and business development. The following factors contribute to reducing the break-even point:
Increase the product’s price.
If the price of the product increases, the break-even point will come closer because the gap between the manufacturing cost and the sales revenue will become smaller with each product sold.
Getting help from external sources
This means using global expertise to produce your desired goods with lower costs. This method is more effective for administrative matters and tasks requiring directional and leadership consultations than manual work.
Conclusion
You can always use the Qoyod accounting system to complete the break-even point calculation and analyze it correctly. It does not require installation on your device, and you can also try it for free for 14 days. Then, you will see how professionals can exploit the break-even points and their indicators to improve the profits of their projects and expand the scope of business in their companies. We will not tell you a secret: performing this type of calculation requires experience and skill to perform it correctly, understand its implications, and avoid losses.
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