Write about Financial breakeven in financial management.

Breakeven point (BEP) is a point where, there is no loss or no gain to the company. It is a point where, company starts earnings profits. Net income or earnings per share is zero. Fixed is independent of volume of sales and variable cost is dependent on volume of sales.

Formula

We know,

Net income = EBIT * (1-IE) * (1-TR) – PD

At breakeven point (EBIT), Net income = 0

0 = EBIT * (1-IE) * (1-TR) – PD

• EBIT = (PD/(1-TR))+ IE

• BEP (in units) = FC / (RPU-VCPU) (Accounting breakeven)

• BEP (sales in $) = FC / (SPPU*BEP in units)

Here BEP = Breakeven point. FC= Fixed costs, RPU = Revenue per unit, VCPU = Variable cost per unit, SPPU = Sale price per unit, IE = Interest expenses, TR = Tax rate, PD = preferred dividends.

Assumptions related to BEP are −

• Fixed cost = variable cost = constant.

• Applies to only one product.

Factors contributing to an increase in BEP are −

• If the demand for the product is high, then company needs to produce more goods to meet their demands. Increase demand means increase in sales and BEP is raised to meet the demand.

• Variable costs increase BEP. Increase in raw material cost will increase additional expenses; increase in other expenses like rent, salaries, utility rates will also increase BEP.

• Equipment failure increases BEP by having higher operational cost.

Factors contributing to the decrease in BEP are −

• Increase product price may decrease customer base which, indirectly decreases BEP.

• Outsourcing.

Advantages of BEP includes −

• It relates between fixed and variable costs.

• Effect of cost can be forecasted.

• It forecasts change in sales price.

Disadvantages of BEP includes −

• It is time consuming.

• It only applies to single products.

• Total production is equal to total sales.

• Assumes sales price is constant at output.