Break-even point - an ideal factor for profit analysis

The analysis of how this profit is made, its level and future prospects is important for a healthy economy with stable prospects and gains for all parties involved. One component to be taken into account is the break-even point, i.e. the point at which the total costs involved in producing a product or service are fully covered by the profits from the sale of that good or service. Breakeven analysis can give useful guidance, particularly for new business people, but also for those who have extensive experience in the business they run.

Publishing date: 2 February 2023.

In the article below you will find out what the break-even point is, what are the calculation methods that can be used to get the right figures, by looking at an example that is easy to understand, even for people with minimal experience in entrepreneurship. You will also be able to discover how to analyse the data resulting from the break-even calculation and consult some tips that are viable solutions for reaching the break-even point as quickly as possible.

Content:

1. What is the break-even point

1.1. How to calculate the break-even point

1.2. Examples of break-even point calculation

2. How to carry out the break-even analysis

2.1. Steps to take for the correct break-even analysis

2.2. Results of the break-even analysis

3. Solutions to reach the break-even point

1. What is the break-even point

The break-even point is an economic indicator to be considered by new entrepreneurs who have recently opened a business and by experienced managers who intend to make major changes in the way they run their business. The breakeven indicator, also known in business jargon as the break even point, is an indicator that highlights the ratio of costs to revenues.

Basically, taking the two elements together results in a point in time at which all the revenue resulting from the marketing of a good or service is equal over a given period of time to all the costs used to produce that good or service. The break-even point equals zero, the conclusion being that economic activity is at a point of equilibrium, with neither losses nor profits.

Finding out when this equilibrium point is reached is of particular importance, because an analysis can be applied to take the right measures to maximise the chances of profit. These measures can be both remedial ones, when the threshold is not reached, and indicators that highlight success and show that the business is on track.

1.1. How to calculate the break-even point

Calculating a firm's break-even point is easy to do, involving simple mathematics. Interested parties can use two different procedures, but with similar results. The first method is a mathematical formula, in which a ratio between turnover and total level of expenditure is required. The result of the division can be zero, which indicates break-even, it can be negative, which indicates that there are problems in the management of the business, or it can be positive, which indicates profit and therefore success.

In order to make an accurate calculation, the correct calculation of the company's turnover will be taken into account. In order to obtain this indicator, all existing fixed expenses will be added together with all variable expenses. In order to determine the fixed costs, the salaries of all staff, including social security contributions paid to the state, utilities such as electricity, hot water, cold water, etc., rent of premises, taxes to the state, accounting and promotion costs, depreciation of means of production and money used to sell products, etc. Basically, these fixed costs are those which are paid month after month in similar amounts. Variable costs consist of those payments that may vary over time, such as maintenance and repair of various equipment, purchase of raw materials, employee salaries, etc.

The second variant is a graphical process, expressed in the form of a chart showing variable and fixed costs and total sales revenue. At some point these lines intersect, that point being the break-even point. This method has the advantage of showing exactly what is the minimum number of products that need to be sold to break even.

1.2. Examples of break-even point calculation

The example of the break-even calculation is useful to help any entrepreneur, including those who are just starting out and have no economic education, to understand what is the minimum level of goods and services offered to customers that will ensure that they reach the break-even point, i.e. where expenses equal revenues.

For example, if an entrepreneur wants to open a coffee shop offering various types of drinks such as espresso, classic coffee, cappuccino, mocha, and wants to know the minimum level of sales over a given period of time (day, week, month) that will ensure a level of income with which he can fully cover his expenses, he needs to know the total price of producing a coffee of a given type.

In setting the right price, he must take into account all fixed and variable costs, such as rent for the period of time, salaries of any employees, raw materials, utilities, taxes to the state, promotion costs and administrative expenses. Applying the formula in this case is very simple. After calculating the total costs the result is divided by the price of a coffee. The sum obtained is the number of products that have to be offered for sale in a given period of time in order to collect enough money to pay for all expenses.

For example, such a calculation would mean that in one month, where the expenses are ten thousand lei and one coffee costs ten lei, one thousand coffees would have to be sold in that period. If it is not possible to achieve this level for various reasons, then the business will certainly make a loss. If exactly one thousand coffees are sold, then there will be no profit, but no loss. Anything that can be sold above the level of a thousand coffees is profit for the entrepreneur.

2. How to carry out the break-even analysis

The analysis of economic indicators can be done by each individual manager. A good idea for the beginner in particular is to use the services of business consultancy firms, which offer various services such as accounting and legislative advice, financial auditing services to ensure correct calculation, correct interpretation of the results obtained and to generate useful advice for making the best decisions.

2.1. Steps to take for the correct break-even analysis

A proper economic analysis depends on the accuracy of the data entered. In order to achieve this, managers who want to know the health of their business need to take some essential steps:

• Correct calculation of fixed costs (all those expenses paid regularly to employees, suppliers and the state must be taken into account);
• Identifying variable costs (these only arise at certain times, usually without knowing that they will arise, and it is important to keep accurate accounts to help identify these costs);
• Setting the selling price of the product at a level at least equal to the production price;
• Correct application of the mathematical or graphical method of calculating the break-even point.

2.2. Results of the break-even analysis

Break-even analysis can provide useful information for making good business decisions. In order to get some elements that help in this respect, the calculation of profitability should be done taking into account some basic rules:

• In order to obtain the most accurate figures possible, break-even calculations should be done regularly, at relatively short intervals (one month, half a year or a year). This practice allows problems to be spotted early on and action can then be taken without delay to reach the break-even point;
• The figures obtained should not be considered absolute. There are some variables that cannot be taken into account, such as stocks, and for this reason this indicator is only an indicative one, showing the health of the business;
• Although an analysis can be carried out for the whole business, it is more efficient to apply the formula for each individual product.

Interpretation of the data resulting from the analysis can be useful in several circumstances:

• One can find out exactly how quickly a newly started business becomes profitable. This is useful in determining the level of investment that needs to be in place before revenues can exceed costs;
• It shows whether some action needs to be taken if the result is negative. This can be done either by limiting fixed costs or by increasing the price of the product or service offered;
• The calculation can also be used before the start of a business, as it shows whether it is possible to make a profit or whether the business is doomed to failure.

Another advantage of establishing the break-even point is that another economic indicator, known as the safety margin, can be calculated using it. The safety margin is expressed as a percentage and shows how much economic activity can be limited without jeopardising the business. Thus, if the safety margin is more than 20 per cent of turnover, certain changes can be made without jeopardising profitability. But if the margin is below 10 per cent of turnover, the company is in a difficult situation and any limitation of production can lead to economic problems, even very serious ones.

3. Solutions to reach the break-even point

Reaching the break-even point is intended to be achieved as close as possible to the start of a business. Basically, until that point the entrepreneur earns nothing and has to spend the money invested without making a profit. For this reason, a sustained effort must be made to break even within a minimum period of time after the start of the business. In order to achieve this goal, specialists offer some tips that can be used successfully in all circumstances:

• The first step should be a well-developed business plan based on accurate calculations and thorough initial information;
• Economic studies are not compulsory, as many successful entrepreneurs are self-taught, but they can be an important support in the business. It is not obligatory to complete a long higher education, but there is also the option of specialisation courses in specific fields, such as tourism, commerce, organic farming, trade, etc.;
• Business consultancy plays a special role in all stages of business. Business planning, start-up and management can benefit from the in-depth knowledge of specialists;
• Artificial intelligence is helping managers. It is present in the software used by more and more entrepreneurs, known as ERP software. These software programmes offer many useful options at all stages of the business (inventory, accounting, invoicing).

In conclusion, new and experienced entrepreneurs should calculate their break-even point at regular intervals in order to know the health of their business and to be able to make timely managerial decisions if they notice any shortcomings.

*This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.