How to calculate Break Even Point (BEP)
The Break-Even Point is the point where the market price of an asset equals its original cost. Find out how break-even point is calculated, what it is used for and where to find it.
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Companies often calculate their break-even point or BEP, especially when an entrepreneur is launching something new onto the market. In fact, break-even point analysis is an essential part of creating a business plan, as it helps to reduce business risk.
You can use break-even point with investments in certain circumstances as well, for example when you want to assess an investment’s performance and, in particular, the relationship between return and incurred costs.
Let’s take a look in detail at how break-even point is calculated, what it’s used for and where to find it.
What is the break-even point?
The break-even point is a parameter used to identify the amount needed to cover costs. So basically, it’s the point of balance between expenses and revenues that indicates when the costs break even. BEP is widely used in business, for example to understand how many products a company has to sell before its costs are covered.
When the break-even point is reached, it means that profits are equal to losses. In other words, revenues have allowed all expenses to be redeemed. In addition to risk control and business planning, the BEP can also be used to monitor production activities so a business is in a position to intervene immediately if the break-even point isn’t reached.
Another use of the BEP is in the real estate sector, where it shows the return a property must generate to cover the amount it cost. In finance, the break-even point is used to understand when the price of a security allows you to pay off transaction fees, such as broker's commissions, taxes and management fees. An investment’s BEP is the value that allows costs to be reset to zero and above which a profit can be generated.
Break-even point formula
Calculating the break-even point is quite simple and you don’t t need any complex mathematical formulas. To work out the BEP for a product in a business environment, all you need to do is add up your fixed costs, then divide that amount by the sale price for each unit of product minus the variable costs attributable to it (so your net profit on each product sold).
Break-even point = [fixed costs / (sale price per unit of product - variable cost per unit of product)]
This will give you an indication of how many products you need to sell to recoup your expenses and start earning money. For example, let’s assume that a company has fixed costs of £5,000, sells its product at an average price of £30 and the cost per unit of the product is £18. The BEP will be 416, so the company will have to sell 417 products before it starts generating profits.
How to find the break-even point?
In the finance sector you can also calculate the break-even point of an investment, so you are aware of the price level which has to be reached before making a profit.
For example, in options trading, the BEP equals the price that the underlying asset must be at so that exercising the option doesm’t result in a loss.
Let's look at an example with options to get a better understanding of how BEP works in trading. Let’s imagine that we bought a call option on Microsoft shares with a strike price of £280 and paid a premium of £5. That means we can buy Microsoft shares at £280 per share before the option expires and exercise this right at any time.
The break-even point in this case is £285, which is the strike price plus the premium, so if the market price doesn’t exceed the BEP, it isn’t going to be profitable to exercise the option. On the other hand, if Microsoft's share price exceeds £285 and reaches £300, you can exercise the option and make a profit; in fact, you can buy Microsoft shares at £280, pay a £5 premium and sell them at £300 with a profit of £15 per share.
The BEP can be calculated for any type of investment. It’s a simple operation that is very useful for investors and traders as it allows them to keep an eye on costs and understand when an investment actually becomes profitable. Costs are a factor you do need to take into account when you’re investing as they can reduce earnings quite considerably depending on the intermediary and the type of financial transaction carried out.
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