Concept of Break-Even Sales
The break-even point is where a business neither makes a profit nor incurs a loss. It's determined by the intersection of total cost and total revenue on a graph, indicating the cost of production. Break-even sales refer to the number of units needed to cover manufacturing costs. This concept reveals the relationship between fixed and variable costs and revenue. Businesses with lower fixed costs have lower break-even sales.
Components of Break-Even Analysis
A company can calculate the total cost of production through two primary components. They are as follows:
1. Fixed costs: Overhead costs, also known as sunk costs, are the fixed expenses incurred by a company when starting operations. These costs, such as rents, depreciation, taxes, salaries, and interests, remain constant regardless of production output.
2. Variable costs: Variable costs fluctuate based on production volume and include expenses such as raw materials, packaging, and fuel. Lower fixed costs lead to a lower break-even point. For example, an ice-cream stand's variable costs vary based on the number of scoops, cones, and materials used.
Maximizing profits is extremely important for entrepreneurs, but more important than that is to break-even. Watch the video to understand how we can know if we achieved that.