The breakeven point, also called the critical point, is the volume of production at which total costs are equal to the proceeds from the sale of goods, where the result is zero. Economic activity becomes profitable after its result exceeds this point.
What advantages does this method of analyzing profitability offer:
- allows to determine the moment when production becomes profitable;
- indicates the volume of production required to obtain a certain profit;
- highlights the correlations between the dynamics of production, revenues and the dynamics of income on variable and fixed costs;
- allows to determine the degree of production capacity in correlation with a desired profit.
Where and when it is necessary to analyze the breakeven point:
- current activity, when changing the level of activity / production;
- studying the consequences of increased sales or turnover;
- studying methods and plans for modernization or refurbishment of production.
How is the unit profitability threshold determined?
This critical point is encountered when the turnover is equal to the total expenses. The higher the turnover, the lower the risk of exploitation. The result is that the unit adapts quickly to changes in the environment through the amount of production obtained.
The difference between the breakeven point and turnover is called absolute flexibility or safety margin. This indicator shows the extent to which the volume of activity can fluctuate, without this implying losses.
The further the turnover is from the breakeven point, the greater the financial stability of the unit. This method allows the prediction of the economic situation when changing the activity level.
The safety margin is an element carefully analyzed by banks in the event of a possible loan and is the basis of decisions on the future development of the unit.
How to determine the breakeven point on a product
The methodology of determination takes into account the evolution of costs and revenues when changing the volume of production. When costs evolve in direct proportion to the volume of production, the linear model of evolution of variable costs and revenues is used.
Graphic fixed costs have the shape of a line parallel to the axis of production volume. The variable cost line starts from the origin and increases, and the total costs have an upward linear evolution.
If the selling price is unchanged over time, the total revenue will be represented by a straight line with a higher slope than the total cost. For a higher production (volume of activity), profit is made, while for a lower production you’ll have losses.
Profit can be increased by manipulating cost and price variables as follows:
- reduction of fixed costs through preventive maintenance of equipment, use of equipment with lower consumption, etc.;
- reducing the variable cost by lowering consumption of raw materials, purchasing materials at lower prices, judiciously organizing work processes;
- price increase is possible by enhancing the quality and competitiveness of the product.
The break-even point’s determination, as well as its analysis is made in connection with the specific evolution of costs and prices, due to the short-term variability, especially in the conditions of inflation.
As the numbers taken into account change, the breakeven point needs to be updated. Knowing it allows the calculation of the safety margin on which financial decisions are based.
