Question

Explain why break even is so important. Describe the elements of break even and write the formula for break even.

Answer 1

Answer:

A break-even analysis is an economic instrument that is used to assess a company's cost structure or the number of units that need to be sold to cover the costs. Break-even is a condition in which a corporation does not make a profit or a loss, but recovers all the money invested.

Break-even is so important because of the following reasons:

1. The business or the owner gets to know how many units need to be sold to cover the cost with the aid of break-even analysis. To calculate the break-even analysis, the variable cost and the selling price of an individual product and the overall cost are needed.
2. Break-even guides the firm in the formulation of pricing strategy. If there is some improvement in a product's pricing, the break-even point can be affected. For instance, if the selling price is increased, the amount of the commodity to be sold will be reduced to a break-even stage. Similarly, a business has to sell extra to break-even if the sale price is reduced.
3. When a corporation or the owner knows at what point a corporation will break-even, it makes it easier for them to set a goal and set a target for the company accordingly. In setting a reasonable objective for a company, this analysis can also be used.
4. The profit margin of businesses can be influenced by the fixed and variable costs; thus, the management can detect whether any effects change the cost with break-even analysis.

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Elements of Break-even

There are three elements of Break-even:

1. Fixed Cost
2. Variable Cost
3. Selling Price

• Fixed Cost

Fixed Cost is the cost that a firm always incurs. It does not matter whether the firm is engaged in the process of production or not. For example, Rent, Taxes, etc.

• Variable Cost

Variable Cost is the cost that increases with the increase in operations of a firm and decreases with the decrease in the operations of a firm. Hence, there is a direct relationship between the variable cost and the level of output. For example, the cost of raw material, advertising cost, etc.

• Selling Price

The Selling price is the unit price at which a product is sold in the market.

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Formula for Break-even

For example,

Fixed Cost = $100,000

Selling price per unit = $25

Variable Cost per unit = $5

  

  

Hence, the Break-even point is at 5000 units.

To calculate the break-even point in amount, multiply the units calculated at break-even point with the selling price per unit.

Hence, break-even point (in dollars) =

= $125,000