To start a business, you will need to spend some money. These expenses might be to get things like a location (if it is a business that requires a physical location). It could also be to purchase equipment, products, etc. It naturally means that you are starting the business at a loss. You will need to move it from that point to where you are no longer at a loss. This is what break even point is all about. This article answers the question, what is break even point and how does it apply to Nigerian businesses.
Simply put, break even point is the point at which the total amount spent on purchasing goods and/or assets and the amount spent on operating a business is equal to the total amount made from the sales the business makes (I.e the revenue). At this point the business has made back the money it spent on getting the business up and running, even though it hasn’t made any profit.
For example, if you buy 1000 pencils and a pencil cost you ₦5 and the price of transporting it to your shop is ₦50, you will need to have made ₦5050 in sales to reach break even point. Besides sales, break even point can apply to investments and the stock market also.
Why Businesses Use Break Even Analysis
The break even point shows the sales amount of a business and can either be represented in terms of unit (quantity of goods sold) or revenue (amount made from sales). The total profit at this point is zero. The business passes the break even point when the selling price of their products has exceeded the total amount they spent to get the goods (both the fixed and variable costs). Basically, at this point, the business begins to make a profit.
In financial analysis, businesses frequently use the break even point. Marketers, accountants, entrepreneurs, financial planners, etc. use the break even point analysis. The break even point aids all parts of a business. It helps employees or entrepreneurs know what their target, in terms of sales, is and how to work towards it.
Depending on the type of business, break even value may be high or low. The type of business notwithstanding, it is critical that there is a break even point calculation. This is so they can know, exactly, how many units of their products they will need to sell to meet the break even point.
Calculating the break even point helps businesses know what decision to make to make profit. For example, the business can reduce cost by either changing their supplier to one that is cheaper or by reducing operational expenses.
Break Even Analysis
Break even analysis gives insight to the amount of sales of products that is needed to cover the total cost (fixed and variable) of a company or business. It basically tells you that if you want to break even, you will need to sell x number of your product or sell your service for x amount. Break even analysis can be used for stock trading, options trading, corporate budgeting for different projects, etc. It has a broad application in business.
Break Even Analysis Formula
The break even analysis formula is:
Break even quantity = Fixed cost ÷ (sales price of one item – variable cost of one item)
Fixed Cost: The costs that remain constant in a business’s operations regardless of varying outputs (e.g rent, salary, equipment)
Variable Cost: The cost of manufacturing or purchasing an item for sale.
A pure water company has a fixed cost of ₦100,000 from rent, electricity bill and salary. The variable cost of making one sachet of water is ₦5 and each sachet is sold for ₦10. To calculate this pure water company break even point:
Break even point = ₦100,000 ÷ (10-5) = 20,000
So this pure water will need to sell 20,000 sachets of water in order to break even.
The break even analysis can be represented in graphical form, and it is known as break even chart.
This is how to interpret the graph above:
Where the line for the fixed cost, the total cost (fixed and variable) and the revenue meet is the break even point. This point is known as the “no profit” and “no loss” point.
- You have profit if revenue > total fixed cost + total variable cost
- You have break even when revenue = total fixed cost + total variable cost
- There is a loss when revenue < total fixed cost + total variable cost
Importance Of Calculating Break Even Point
- Break even analysis lets businesses know exactly how much sales is needed to make profit and avoid loss. This helps entrepreneurs know which business opportunity to go for as they will know which business will produce the highest profit with the littlest output.
- Knowing the break even point will help a business person reduce their risk because if a product sells below the expected price or market conditions change, they will know before hand where the break even point will be and they will be able to adjust their expenses to still meet the break even point.
- Break even analysis helps businesses make better budgets because you can tell, before hand, how profitable the business will be in a month or a quarter or in a year.
- The break even analysis can serve as a motivational tool that will make business people and entrepreneur improve their work and marketing tactics to increase profitability.
Does It Apply To Nigerian Businesses?
It is clear from the points above that the break even point applies to Nigerian businesses. Some medium and large scale businesses know about the break even point and apply the results of the analysis in their marketing and sales effort. A lot of small businesses, however, can’t be bothered about what it is. It is however vital that every business do a regular break even analysis regularly, especially when they are just starting the business.
My name is Emmanuel Ejiga. Content lead of OG Capital
I am a writer. Technical writer, song writer, and sometimes fictional writer.