In accounting, the break-even point refers to the revenues needed to cover a company's total amount of fixed and variable expenses during a specified period of time. The revenues could be stated in dollars (or other currencies), in units, hours of services provided, etc.
The break-even calculations are based on the assumption that the change in a company's expenses is related to the change in revenues. This assumption may not hold true for the following reasons:
- A company is likely to have many diverse products with varying degrees of profitability.
- A company may have many diverse customers with varying demands for special attention. Hence some expenses will increase for reasons other than the sale of additional units of product.
- A company may be selling in a variety of markets. This could result in the selling prices in one market or country being lower than the selling prices in another market or country.
- The company may see frequent fluctuations in its sales mix.
The basic calculation of the break-even point in sales dollars for a year is: fixed expenses (fixed manufacturing, fixed SG&A, fixed interest) for the year divided by the contribution margin ratio or percentage.
The basic calculation of the break-even point in units sold for a year is: fixed expenses for the year divided by the contribution margin per unit of product.
If we assume that a company's fixed expenses are $480,000 for a year, the variable expenses (variable manufacturing, variable SG&A, variable interest) average $8 per unit of product, and the selling prices average $20 per unit (resulting in a contribution margin of $12 or 60% of the selling price)...
- the break-even point in sales dollars is $800,000 [$480,000 divided by 60%]
- the break-even point in units of product is 40,000 [$480,000 divided by $12 per unit]