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What is financial breakeven point in accounting?
The term breakeven point in terms of accounting is nothing but, in a particular accounting period the firm revenues is exactly as same as expenses. This is denoted as BEP (Break Even Point). It tells about number of units to be sold to meet the expenses. It also helps in calculating zero operating margin.
Formula − (total fixed cost/price per unit) - variable cost
Financial breakeven point is a point where earnings before income tax (EBIT) is equal to financial cost of a firm (or) earnings per share (EPS) is equal to zero. It is useful in calculating zero net income. It also helps in at which earnings per share is zero.
Net income = EBIT * (1-Interset expenses)*(1-tax rate)-preferred dividends
Net income = 0,
Financial breakeven point (EBIT) = (preferred dividends/ (1-tax rate)) + interest expenses
Factors that increase firm breakeven point are −
- Breakeven point increases when customer sales increases.
- Breakeven point increases when production cost increases.
- Breakeven point increases when there is repair in equipment.
Factors that reduce the breakeven point are −
Breakeven point will be reduced when product prices are raised.
Breakeven point will be reduced when business opts for outsourcing.
A firm has three financial plans to their new project. Rs. 2,00,000 in equity (option one), Rs. 1,50,000 in equity and Rs. 50,000 in 9% debentures (option two). Rs 90,000 in equity, 60,000 in 9% debentures and Rs. 50,000 in 12% preferred share capital. Calculate breakeven point at 40% tax rate.
Option 1 − Since there is no interest expenses and preference dividends, Breakeven point = 0
Option 2 − There are only interest expenses and no preference dividends,
Financial breakeven point will be = 9% (50000) => Rs. 4500/-
Option 3 − Financial breakeven point = ((50000*12%)/ (1-40%)) + (9%*50000) => Rs. 5500/-
From the above, as company takes more on debt financial breakeven point will increase.