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How to Define and Calculate the Break-Even Point with Examples
Understanding the break-even point definition is essential for companies, chief operating officers, and accountants. It is also crucial for traders and investors. Without knowing the break-even point (BEP) of a product, service, trade, or investment, any operations will lack efficiency and could operate at an underlying loss despite showing an overlying profit.
Imagine placing ten trades, closing them at fractional profits, but facing a loss. While this may sound unlikely, it can occur if traders fail to conduct a break-even point analysis. It applies to any trading strategy, but scalpers and other high-frequency or high-volume traders face the most significant risk as they capture small moves in price action.
We will cover the break-even point definition, provide the variations of a break-even point formula, and explain it with a break-even point example below.
What is the Break-Even Point Definition?
The break-even point, or the break-even price in financial markets, is the level representing neither a profit nor a loss exists. The break-even point equals the total revenues subtracted from the total production costs. When the equation equals zero, the company has reached its break-even point, and each additional sale will result in a profit. It applies to companies producing a good or service, but how do financial markets define a break-even point? In financial markets, the break-even point equals the current price minus the entry price plus trading costs.
When does a Break-Even Point Apply?
A break-even point applies when a good or service enters production, or traders and investors take a position. In business, fixed and variable costs and the selling price impact the break-even point. In finance, the entry price presents the starting point. Trading costs impact the break-even price, especially for leveraged traders, where the break-even price increases each trading session.
Break-Even Point Examples
What is a break-even point in business? How about for an unleveraged investment or leveraged trade? Our below examples will illustrate how to find a break-even point.
A break-even point in business:
Business can either determine their break-even point by how many units they must sell or by required revenues. Assume a company has fixed costs of $10,000, variable costs per unit of $50, and a sales price of $75 per unit.
Here is a break-even point unit example (accounting):
$10,000 (fixed costs) / ($75 (unit price) - $50 (variable cost)) = 400 units
The company will break even with the 400th unit sale and turn a profit from the 401st unit sale. Anything below 400 units results in operating losses for the company.
Here is a break-even point revenue example (financial):
$10,000 (fixed costs) / [($75 (unit price) - $50 (variable cost)) / $75 (unit price)] = $30,000
The company will break even with $30,000 in revenues, meaning it neither recorded profits nor losses. Subtracting the variable cost from the unit price and dividing it by the unit price provides the contribution margin ratio. Multiplying the required units by the unit price will also yield the necessary revenues to break even.
A break-even point example for an unleveraged investment:
Assume an investor buys 1,000 shares in a company at $30 per share and pays a 0.10% commission when buying and selling.
- 1,000 (shares) x $30 (share price) = $30,000 (total investment)
- $30,000 (total investment) x 0.10% (commission rate) = $30 (commission)
- $30,000 (total investment) + $30 (commission) = $30,030 (total investment cost)
- $30,030 (total investment cost) / 1,000 (shares) = $30.03 (break-even price)
The break-even price of $30.03 presents the partial break-even price, as the investor will pay an additional 0.10% when selling the investment. Therefore, approximately $30 or $0.03 in extra costs increases the break-even price to $30.06, meaning $30.07 results in a profit. The accurate break-even price is between $30.06 and $30.07, but equity investment pricing remains limited to two decimals.
A break-even point example for a leveraged trade:
Assume a trader buys 1.0 standard lot in the EUR/USD at 1.05000, pays a commission of $4.00 per round trip, and a swap rate of $2.50 daily.
- The pip value is $10.00, referring to the fourth decimal, making the fifth decimal a pipette valued at $1.00
- A trade open past one rollover date, at which point financing charges apply, incurs total costs of $4.00 (commission) plus $2.50 (daily swap rate) or $6.50
- Therefore, the break-even price is 1.050065, rounded up to 1.05007
- Keeping the position open for four days increases the break-even price to 1.00514, consisting of $4.00 (commission) plus four times $2.50 for total costs of $14.00 or 1.4 pips
The Difference Between the Accounting and Financial Break-Even Point
When calculating the break-even point in economics, the two most common methods are accounting and financial. The primary difference is that accounting calculates the required units to achieve break-even, while financial computes the necessary revenues.
What is the Break-Even Point Formula?
The break-even point equation is straightforward, and there are two primary formulas, one for the accounting break-even point and the other for the financial break-even point.
The accounting break-even point equation:
Fixed costs / (unit price - variable cost) = accounting break-even point
Here is an example:
$10,000 (fixed costs) / ($75 (unit price) - $50 (variable cost)) = 400 units
The financial break-even point equation:
Fixed costs / [(unit price - variable cost) / unit price] = financial break-even point
Here is an example:
$10,000 (fixed costs) / [($75 (unit price) - $50 (variable cost)) / $75 (unit price)] = $30,000
Factors Impacting the Break-Even Point
Several factors impact the break-even point, and they differ for businesses, traders, and investors.
- Demand (if more units warrant fixed cost expansions), production costs (raw materials and labor costs), and equipment repairs (which take production offline) can impact the break-even point for businesses
- Commissions (when buying and selling assets) and dollar-cost averaging (adding to the position at different prices) are two primary factors investors must consider
- Commissions (when entering and exiting the trade) and financing charges (applied daily on leveraged positions) influence the break-even price for traders, and it increases daily
How can the Break-Even Point be Reduced?
Businesses can reduce their break-even point by increasing their unit costs or lowering their fixed and variable costs. The former lowers the contribution margin ratio, while the latter can include optimizing the production process via efficiency or outsourcing it.
Investors can achieve a lower break-even price by using a low-commission broker, and traders by using a broker with volume-based rebate programs and tight spreads.
Break-Even Point Conclusion
It is essential to know the break-even point definition, as it allows for efficient operations, cost savings, and revenue expansion. Gross profits can yield net losses and high-quantity profitable trades in an overall loss without knowing the break-even point or break-even price.
FAQs
How to find the break-even point in dollars?
Fixed costs / = financial break-even point in dollars.
What happens when the firm achieves the break-even point?
At the break-even point, a firm neither records profits nor losses.
Why is the break-even point important?
The break-even point separates profits from losses and helps streamline operations.