Understanding Breakeven Point (BEP): A Comprehensive Guide
The breakeven point for a trade or investment is calculated by comparing the market price of an asset to its original cost; it is reached when both prices are equal.
In corporate accounting, the breakeven point (BEP) formula is determined by dividing the total fixed costs associated with production by the revenue per individual unit minus the variable costs per unit. Fixed costs are those that remain constant, regardless of the number of units produced. Simply put, the breakeven point is where total revenues for a product equal total expenses.
Key Takeaways
- The breakeven point is the production level at which costs match revenues.
- It helps in setting sales goals and identifying the profitability of new production.
- In the trade and investment context, the breakeven point is reached when an asset’s current market price matches its original cost.
- A breakeven analysis is valuable for revealing hidden expenses, making rational decisions, setting goals, obtaining funding, and pricing products accurately.
Different Contexts of Breakeven Points (BEPs)
Real Estate
In property, the breakeven point includes net purchase price plus closing costs, taxes, fees, insurance, interest on the mortgage, and maintenance expenses. This ensures that the homeowner neither profits nor incurs a loss on sale.
Corporate Accounting
Companies use profit-volume charting to track earnings or losses and set sales goals accordingly. BEP here equals fixed costs divided by the gross profit margin percentage.
Investing and Trading
Investors determine the breakeven point to cover all trade-related costs. For trades, BEP also includes taxes, commissions, and management fees. It’s the fixed costs divided by the gross profit margin.
Benefits of a Breakeven Analysis
- Finding Missing Expenses: Helps identify unforeseen expenses to avoid future surprises.
- Rational Decision-Making: Bases decisions on concrete data rather than emotions.
- Goal Setting: Clearly shows what goals are necessary to achieve profitability.
- Securing Funding: Essential for attracting investment and demonstrating a solid business plan.
- Appropriate Pricing: Guides on how to price products to ensure business viability.
BEP in Stock Market
Assume you buy Microsoft stock (MSFT) at $110. The breakeven point is $110; you make a profit if the price rises above $110 and a loss if it falls below $110.
Options Trading Breakeven Points
Call Option Example
If an investor pays a $5 premium for an Apple stock (AAPL) call option with a $170 strike price, the breakeven point is $175 ($170 + $5). A $190 stock price means the investor earns $15 per share.
Put Option Example
For a $4 premium on a Meta (formerly Facebook) put option with a $180 strike price, the breakeven point is $176 ($180 - $4). If the stock is traded at $170, the profit per share is $6.
BEP in Business
Breakeven analysis in business calculates the dollar figure to break even. By determining the contribution margin (unit sale price - variable costs), one can divide fixed costs by the contribution margin to know the sales needed to break even.
Assume a company with $1 million in fixed costs and a 37% gross margin has a BEP of $2.7 million. With a $50 unit sale price and $10 variable cost, the contribution margin is $40. The breakeven sales units required are 25,000 ($1 million / $40).
What is Breakeven Point?
It denotes production level where total revenue matches total costs in accounting. In investing, it aligns original cost with current market price. For options, it’s the market price where the underlying asset would result in no loss.
How to Calculate BEP?
In business, divide fixed costs by the gross profit margin for a breakeven figure. For stocks, if a trader buys at $200 and it returns to $200, it hits BEP.
Calculate BEP in Options Trading
For a call option with a $10 premium and $100 strike price, BEP is $110. For a put option, it’s $90.
Conclusion
Breakeven points are critical for not incurring losses by ensuring projects or trades generate profits equaling their initial costs. This applies to both business strategies and individual trades or investments. Prices, yields, commissions, taxes, or inflation impacts can also adjust BEP.
Related Terms: fixed costs, variable costs, gross profit margin, contribution margin, option trading.
References
- OpenStax, Rice University. “Principles of Accounting, Volume 2: Managerial Accounting; 3.2 Calculate a Break-Even Point in Units and Dollars”.
- CME Group Education. “Explaining Put Options (Short and Long)”.
- CME Group Education. “Explaining Call Options (Short and Long)”.
