The break-even point is a business terminology which refers to the level of output or activity wherein a firm’s total revenue exactly equals its total cost. At this point, the business entity covers all its expenses but earns no profit. The operating income is therefore zero. The break-even point is exactly where a business entity crosses the line between being a losing operation to being a profitable venture. A business entity’s total operating cost is the sum of its fixed and variable costs. Fixed costs refer to expenses that are not a function of output and thus, do not vary with the production level.
Fixed costs include such items as administrative salaries, property taxes, and insurance premiums. Other things constant, the break-even point varies in proportion to the fixed cost; an increase in the fixed cost translates to a corresponding rise in the break-even point. A fixed cost increase leads to a higher break-even level of output, depending on the degree of increase. In reality, it corresponds to the fact that a higher fixed cost would entail the need to produce more output in order to cover the total expense.
Variable costs, on the other hand, are costs that change in direct proportion to the output level; each planned percentage increase in output will yield an equal increase in the variable cost. Variable costs include such items as raw materials and direct labor costs. An increase in the variable cost actually generates an equal increase in the total cost at each level of output, thereby raising the output level at which the firm will “break even”. In this sense, a variable cost increase leads to a higher break-even level of output. On the revenue side, bigger sales receipts mean either higher sales prices or greater sales volumes.
A higher unit sales price is tantamount to a higher per-unit profit and in this sense, a lower break-even level of output. The higher profits generated by a unit sales price increase lessen the output level necessary for the firm to break even or cover its operating expense, thereby effectively lowering the break-even point. Unlike fixed and variable costs, the break-even point varies in inverse proportion to the unit sales price. Amidst all the modern business calculation tools, the break-even point concept will remain a useful business reference for generations to come.