The break-even point is the level of activity or sales at which a company makes neither profit nor loss. At the break-even point sales revenue exactly equals total costs. Thus, the sales volume at which operations break even is indicated by the break-even point. Break-even point can be expressed in terms of the number of units sold or in terms of sales value.
We know that,
sales – variable cost = fixed cost + profit
Since at the break-even point profit is equal to zero, it follows that
Sales at break-even point – variable cost = fixed cost
Thus, at the break-even point, the contribution is just enough to provide for the fixed cost. Thus, enough contribution is necessary to be earned to cover fixed costs before any profit can be earned. If the level of actual sales is above the break-even point, the profit will be earned by the entity. On the other hand, if the actual sales are below the break-even point, the loss will be incurred by the entity.
The following formula can be used to calculate the break-even point:
Break-even point in terms of units
= fixed cost/contribution per unit
When the graphical presentation of the cost volume profit relationship is made, the break-even point will be the point at which the total cost line and total sales line intersect each other.
The break-even point is very important to management in that, it shows the lowest level to which the given activity can drop without actually jeopardizing the life of the entity.