Break-Even Analysis

Definition: The Break-Even Analysis is a method adopted by the firms to determine that how much should be produced or sold at a minimum to ensure that the project does not lose money. Simply, the minimum quantity at which the loss can be avoided is called as a break even point. The Break-even point can be defined in both the financial and accounting terms.

Financial Break-Even Analysis
The break-even point can be calculated in terms of Net Present Value (NPV). The financial break-even occurs at a point when the cash flows are equivalent to the initial investments; this is possible only when the NPV is zero. Thus, to realize a break-even situation, each firm tries to find out the level of sales at which the NPV of the project is zero.

Accounting Break-Even Analysis
The break-even point can also be defined in the accounting terms. In accountancy, no profit-no loss situation can be reached by computing the ratio of variable cost to sales. (Suppose, ratio=0.67), this means that every rupee from the sale of each unit makes a contribution of Rs 0.33. Thus the contribution margin ratio comes to be 0.33. Following formula can be applied to realize the accounting break-even point:

BEP = (Fixed Cost+Depreciation) /Contribution Margin Ratio

The other variant of accounting break-even point is, cash break-even point, which shows the level of sales at which the firm neither makes a cash profit nor suffers the cash loss. It can be calculated by applying the following formula:

BEP = Fixed Cost / Contribution Margin Ratio

The project that reaches the break-even point in the accounting term, shows that your investment gives zero returns. Thus, from both the cases you will recover only the investment value and would not get any returns on it.

Leave a Reply

Your email address will not be published. Required fields are marked *

Shares