Break-even point can be defined as the financial point/position where the costs used to produce a certain product equals the revenue it generates. At this point, the respective firm will have not received any profit or loss (Eddie, 2009).
Mathematically this can be represented by:
- TC is Total Cost
- TR is Total Revenue
When a firm realizes its break-even point, it ought to assess if it will be possible to produce more quantities or not. If it can then they would be better off but if it can’t then they will have to reduce the fixed costs, variable costs or increase the prices of the produce (Peter, 2010).
For instance, assuming the price charged per musical performance is $200, this will be the revenue received.
Now if, as given, the fixed costs are $100, $200 and $200 for gas, travel and food giving a total cost of $500, there would be a loss of $300. This therefore means that if the costs cannot be reduced to below $200 or charges per musical performance be adjusted over $500, there would be incurred losses: a loss of $300 per musical performance. The above can be addressed by renegotiating the charges earned and/or adopt cheaper travelling means.
To calculate the break-even quantity: FC/(P-VC)
This in our example will be:
This means that to realize break-even point, 2.5 performances must be done in a month. To realize profits, more performances must be done. For instance, if 3 performances are conducted in a month, there revenue of $600 would be earned leading to a profit of $100.
The limitations of using this sort of analysis are:
It assumes the rigidity of FC, claiming they are constant.
It only relies on the cost deriving its analysis from it thus not giving the business no prediction of the sales.
It assumes linearity of the variable costs
Eddie, M. (2009). Accounting. London: Pearson Education Limited.
Peter, A. (2010). Accounting and finance: compiled from accounting: introduction. London: Pearson Education Limited.
Steve, A. &. (1999). Cost accounting. London: Jones & Barlett learning.