Break even point is the production level at which a company recovers all its costs. At this volume of output, revenues equal costs, both variable and fixed. If it is possible to increase the level of production beyond this point, the company will make a profit.
What does break even point mean?
It is essential for a business organization to know its break even point. This is the production level that a company must achieve if it is to cover its costs. If it is can produce more, it will be able to make a profit. Being aware of the break even point serves other purposes too. For example, a firm that is making a competitive bid can use this information to set its price. Knowing the break even point also helps companies to estimate their profits. To arrive at the break even point, it is necessary to know the value of three variables: ⇨ Fixed costs ⇨ Variable cost per unit of production ⇨ Sale price per unit Let us see how the break even point can be calculated with the help of an example:
Example of break even point
Sunshine Inc. is a shoe manufacturer. Its production line is limited to a single type of shoe. The cost data of the company is as follows: ⇨ Variable cost per pair of shoes = $15 ⇨ Total fixed costs per month = $5,000 ⇨ Selling price for each pair of shoes = $20 How many pairs must Sunshine make to break even? The sale price of each pair is $20. Of this amount, $15 is required to pay variable costs. Hence, the company is left with $5 ($20 – $15) from the sale of each pair to pay for fixed costs. If it sells 1,000 pairs of shoes per month, it will break even. That’s because 1,000 pairs will provide it with $5,000 (1,000 X $5) towards fixed costs. If Sunshine can make more than 1,000 pairs of shoes per month, it will start earning profits.
Calculating the break even point allows a firm to estimate how much it must produce to recover its costs. This information is useful for working out the viability of a product line and for making profit projections.