All companies are born or arise with a specific purpose, which may be, for example, the increase of the equity of their shareholders or the provision of a service to the community.
It is normal that when planning their operations, the executives of a company try to cover the total cost of their costs and achieve a surplus as a return to the resources that the shareholders have put at the service of the organization. The point at which a company's income equals its costs is called an equilibrium point, where there is neither profit nor loss.
In the task of planning, this point is an important reference, it is an influencing limit to design activities that lead to always being above it, as far away as possible, in the place where the highest proportion of profits are obtained.
Perhaps in reality, the calculation and management of PE is somewhat more complex since the vast majority of companies manage a "mix" of products with different margins, making the unit contribution margin formula almost inoperative. But, globally and using the large numbers of the company, we can calculate the break-even point using the following equation:
With this type of calculation and the constant variation in the behavior of some expenses, it should not be forgotten that this calculation represents a moment of the company. It is like a snapshot and should be reviewed regularly. Let us remember that under this modality the break-even point is obtained as a monetary sales figure, not in units.
Another formula for calculating the break-even point is achieved when the income equals the costs, and can be expressed as follows
Both variable costs and fixed costs must include the productive, administrative, sales and financial costs. Today the latter are very significant.
The breakeven point is determined by dividing the fixed costs by the contribution margin per unit.
The contribution margin is the excess of income over variable costs, it is the part that contributes to covering fixed costs and provides profit.
In the specific case of the break-even point, the total contribution margin of the company is equal to the total fixed costs, there is neither profit nor loss.
Suppose a company sells its items at $ 2.00 per unit, whose variable cost is $ 1.00 and has fixed costs of $ 5,000.00.
The contribution margin per unit would be: $ 2.00- $ 1.00 = $ 1.00
If this company plans selling 5,000 units would achieve a total contribution margin of
$ 1.00 * 5,000 = $ 5,000
This would be necessary to cover its total fixed costs of $ 5,000.00, so it can be affirmed that when selling 5,000 units it is at its equilibrium point.
If we apply the formula for the previous example, the same answer would be reached:
In this situation, the break-even point was calculated in units, because dollars were divided by dollars, if the result is wanted in dollars, the same formula would be applied, except that the contribution margin per unit, instead of dollars, would be expressed in Percentage of sales. Continuing with the same example:
- 1.- If we have fixed costs of $ 5000.00 and we sell $ 5000.00 we are recovering the fixed costs but not the variable costs (the cost of the merchandise), that is, we have a loss. 2.- The equilibrium point depends on both the fixed costs and the contribution margin, which is given by the sale price and the cost of the products. If the contribution margin falls, that is, we sell products with little margin, it forces to increase the break-even point. For example, it drops to 40%.
This implies that two companies with the same fixed cost, but with different margins, one may be earning money and the other, not surprisingly.
Note that in all cases sales cover fixed costs, but that is not enough.
Company 1:
Although your sales are above fixed costs, by reducing the cost of merchandise sold, the contribution margin does not allow you to cover your fixed costs, therefore you have losses.
Company 2:
Despite the fact that it has higher sales and a lower fixed cost, it has losses because the contribution margin is lower (38%), it does not cover fixed costs, this may be caused because the products it sells have very little margin.
Company 3:
It sells twice as much as company 1, has the same contribution margin, 50%, achieves profit.
In conclusion:
While it is true we must have controlled sales, we must also control the fixed costs and the contribution margin or price mix of the products we are selling, all of which must be reflected in the financial statements of each of the companies that we are analyzing.
