Which costs are included in the numerator of the accounting profit break-even point equation?

What is the Breakeven Point?

The breakeven point is the sales volume at which a business earns exactly no money. At this point, a business is able to cover its fixed expenses. The breakeven point is useful for determining the amount of remaining capacity after the breakeven point is reached, which tells you the maximum amount of profit that can be generated. It can also be used to determine the impact on profit if automation (a fixed cost) replaces labor (a variable cost). Yet another possibility is to determine the change in profits if product prices are altered. Finally, the breakeven point can be used to determine the amount of losses that could be sustained if the business suffers a sales downturn.

How to Use the Breakeven Point

Management should constantly monitor the breakeven point, particularly in regard to the last item noted, in order to reduce the breakeven point whenever possible. Ways to do this are noted below.

Cost Analysis

Continually review all fixed costs, to see if any can be eliminated. Also review variable costs to see if they can be eliminated, since doing so increases margins and reduces the breakeven point.

Margin Analysis

Pay close attention to product margins, and push sales of the highest-margin items, to reduce the breakeven point.

Outsourcing

If an activity involves a fixed cost, consider outsourcing it in order to turn it into a per-unit variable cost, which reduces the breakeven point.

Pricing

Reduce or eliminate the use of coupons or other price reductions, since it increases the breakeven point. Also, increase price points whenever this is acceptable to customers.

How to Calculate the Breakeven Point

To calculate the breakeven point, divide total fixed expenses by the contribution margin. Contribution margin is sales minus all variable expenses, divided by sales. The formula is:

Total fixed expenses ÷ Contribution margin %

A more refined approach is to eliminate all non-cash expenses (such as depreciation) from the numerator, so that the calculation focuses on the breakeven cash flow level.

Another variation on the formula is to focus instead on the number of units that must be sold in order to break even, rather than the sales level in dollars. This can be useful for setting sales targets. This formula is:

Total fixed expenses ÷ Average contribution margin per unit 

Example of the Breakeven Point

The management of Ninja Cutlery is interested in buying a competitor that makes ceramic knives. The company's due diligence team wants to know if the competitor's breakeven point is too high to allow for a reasonable profit, and if there are any overhead cost opportunities that may reduce the breakeven point. The following information is available:

The analysis shows that the competitor has an inordinately high breakeven point that allows for little profit, if any. However, there are several operating expense reductions that can trigger a steep decline in the breakeven point. The management of Ninja Cutlery makes an offer to the owners of the competitor, based on the cash flows that can be gained from the reduced breakeven level.

What Is the Break-Even Point (BEP)?

The break-even point (break-even price) for a trade or investment is determined by comparing the market price of an asset to the original cost; the break even point is reached when the two prices are equal.

In corporate accounting, the break-even point formula is determined by dividing the total fixed costs associated with production by the revenue per individual unit minus the variable costs per unit. In this case, fixed costs refer to those which do not change depending upon the number of units sold. Put differently, the break-even point is the production level at which total revenues for a product equal total expenses.

Key Takeaways

• In accounting, the break-even point is calculated by dividing the fixed costs of production by the price per unit minus the variable costs of production.
• The break-even point is the level of production at which the costs of production equal the revenues for a product.
• In investing, the break-even point is said to be achieved when the market price of an asset is the same as its original cost.

Breakeven Point

Understanding Break-Even Points (BEPs)

Break-even points can be applied to a wide variety of contexts. For instance, the break-even point in a property would be how much money the homeowner would need to generate from a sale to exactly offset the net purchase price, inclusive of closing costs, taxes, fees, insurance, and interest paid on the mortgage—as well as costs related to maintenance and home improvements. At that price, the homeowner would exactly break even, neither making nor losing any money.

Traders also apply BEPs to trades, figuring out what price a security must reach to exactly cover all costs associated with a trade including taxes, commissions, management fees, and so on. A company's break even is likewise calculated by taking fixed costs and dividing that figure by the gross profit margin percentage.

Stock Market Break-Even Points

Assume an investor buys Microsoft stock at $110. That is now their break-even point on the trade. If the price moves above $110, the investor is making money. If the stock drops below $110, they are losing money.

If the price stays right at $110, they are at the BEP, because they are not making or losing anything.

Options Trade Break Even Points

Call Option Break Even-Point Example

For options trading, the break-even point is the market price that an underlying asset must reach for an option buyer to avoid a loss if they exercise the option. For a call buyer, the break-even point is reached when the underlying is equal to the strike price plus the premium paid, while the BEP for a put position is reached when the underlying is equal to the strike price minus the premium paid. The break-even point doesn't typically factor in commission costs, although these fees could be included if desired.

Assume that an investor pays a $5 premium for an Apple stock call option with a $170 strike price. That means the investor has the right to buy 100 shares of Apple at $170 per share at any time before the options expire. The break-even point for the call option is the $170 strike price plus the $5 call premium, or $175. If the stock is trading below this, the benefit of the option has not exceeded its cost.

If the stock is trading at $190 per share, the call owner buys Apple at $170 and sells the securities at the $190 market price. The profit is $190 minus the $175 break-even price, or $15 per share.

Put Option Break-Even Point Example

Assume an investor pays a $4 premium for a Meta (formerly Facebook) put option with a $180 strike price. That allows the put buyer to sell 100 shares of Meta stock at $180 per share until the option's expiration date. The put position's break-even price is $180 minus the $4 premium, or $176. If the stock is trading above that price, the benefit of the option has not exceeded its cost.

If the stock is trading at a market price of $170, for example, the trader has a profit of $6 (breakeven of $176 minus the current market price of $170). 

Business Break-Even Points

The break-even formula for a business provides a dollar figure they need 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 provide how many units are needed to break even.

Business Breakeven = Fixed Costs Gross Profit Margin \begin{aligned} &\text{Business Breakeven} = \frac { \text{Fixed Costs} }{ \text{Gross Profit Margin} } \\ \end{aligned} ​Business Breakeven=Gross Profit MarginFixed Costs​​

The information required to calculate a business's BEP can be found in its financial statements. The first pieces of information required are the fixed costs and the gross margin percentage.

Assume a company has $1 million in fixed costs and a gross margin of 37%. Its break-even point is $2.7 million ($1 million / 0.37). In this break-even point example, the company must generate $2.7 million in revenue to cover its fixed and variable costs. If it generates more sales, the company will have a profit. If it generates fewer sales, there will be a loss.

It is also possible to calculate how many units need to be sold to cover the fixed costs, which will result in the company breaking even. To do this, calculate the contribution margin, which is the sale price of the product less variable costs.

Assume a company has a $50 sale price for its product and variable costs of $10. The contribution margin is $40 ($50 - $10). Divide the fixed costs by the contribution margin to determine how many units the company has to sell: $1 million / $40 = 25,000 units. If the company sells more units than this it will show a profit. If it sells fewer, there will be a loss.

What Is a Break-Even Point?

A break-even point is used in multiple areas of business and finance. In accounting terms, it refers to the production level at which total production revenue equals total production costs. In investing, the break-even point is the point at which the original cost equals the market price. Meanwhile, the break-even 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.

How Do You Calculate a Break-Even Point?

Generally, to calculate the break-even point in business, fixed costs are divided by the gross profit margin. This produces a dollar figure that a company needs to break even. When it comes to stocks, if a trader bought a stock at $200, and nine months later it reached $200 again after falling from $250, it would have reached the break-even point. 

How Do You Calculate a Break-Even Point in Options Trading?

Consider the following example in which an investor pays a $10 premium for a stock call option, and the strike price is $100. The break-even point would equal the $10 premium plus the $100 strike price, or $110. On the other hand, if this were applied to a put option, the break-even point would be calculated as the $100 strike price minus the $10 premium paid, amounting to $90.

How is the break even point calculated quizlet?

What is the purpose of accounting profit break even analysis quizlet?

Which of the following costs relating to a doctors office are variable costs?

When a project breaks even on an accounting basis the cash flow for that period will equal?