Article provided by Herb Kimble
At the breakeven point of a business, income is equal to expense and therefore there is no gain or loss. It is the starting point from which an increase in sales or a reduction in costs generates a gain and a reduction in sales or an increase in costs generates a loss.
Why Calculate the Breakeven Point?
The breakeven point is an important reference point that enters into planning and carrying out business activities. By clearly understanding the level of sales needed to cover all costs, you know how many units you must produce, in the case of a manufacturing business, or how many units you need to purchase and sell, in the case of a merchandising business. In a services business, the breakeven point indicates the number of billable hours you must work in order to cover your costs.
At the breakeven point: revenue = fixed costs + variable costs.
Therefore, in order to calculate the breakeven point, you need to determine all the fixed and variable costs involved in the operation. Fixed costs are those that are invariable, and that must be paid regardless of the level of sales. Variable costs are incurred in proportion to the level of sales.
Some examples of fixed costs include: the cost to rent an office, shop, warehouse, factory, or other facilities; base salaries and wages of employees; employee benefit plans, maintenance contracts; contracts for cleaning and security services; advertising contracts; insurance; base costs of utilities such as electricity, gas, water, and sewage; base costs of telephone land lines or cellular telephone; Internet connection; the monthly cost of a domain and website; real and personal property taxes; licenses and permits; depreciation and amortization; and interest and other debt service expenses.
Examples of variable costs include raw materials and supplies; freight; rental of machinery, equipment, and tools for specific jobs; fuel; employee overtime pay; temporary contract labor; repairs and maintenance; office supplies; telephone calls; travel expenses; and sales commissions.
Some costs can be part fixed and part variable. For example, there could be a fixed cost of electricity in order to keep the facilities illuminated and for all the equipment to operate at a minimal level of activity. But in order to manufacture products, more energy is consumed and this excess constitutes a variable cost that depends on the level of production.
Another consideration in calculating the breakeven point, in the case of companies that manufacture or purchase the merchandise they sell, is that variable costs correspond to the units sold and not the units that remain in inventory.
The breakeven point can be calculated in terms of revenues and in physical units.
It is advisable to calculate the breakeven point in terms of revenues when the activity is not clearly recognizable in terms of physical units, or when there are various different products. But even when there are various products, to the extent that you can separate fixed and variable costs and allocate them to the different products, you can calculate a breakeven point by product and thereby have a more dynamic business management tool.
This article was written by Herb Kimble. Herb Kimble runs a film production company called CineFocus Productions in Los Angeles. He is also working toward the release of a streaming network, called urban Flix. Find out more info about Herb Kimble, on his About.me page.
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