Breakeven is the point at which gains are equal to losses. In terms of price action, it is the level at which the risk of the trade is recovered. This means that if the trader chooses to close at that particular price, he neither wins nor loses.
What Is the Breakeven Point (BEP)?
The point at which a trade or investment breaks even, known as the breakeven point (or breakeven price), is determined by comparing the current market price of an asset with its original cost. When these two prices align, the breakeven point is achieved.
In corporate accounting, the breakeven point (BEP) formula is derived by dividing the total fixed costs associated with production by the difference between the revenue per unit and the variable costs per unit. Here, fixed costs denote those expenses that remain constant regardless of the quantity of units sold. Essentially, the breakeven point signifies the production level at which the total revenues generated by a product match its total expenses.
Understanding Breakeven Points (BEPs)
Breakeven points (BEPs) find applications across various domains. For instance, in real estate, the breakeven point for property refers to the amount a homeowner must earn from a sale to precisely offset the net purchase price. This includes closing costs, taxes, fees, insurance, mortgage interest, as well as expenses related to maintenance and home improvements. At this price, the homeowner neither gains nor loses money.
In the business realm, companies utilize profit-volume charting to monitor their profits or losses by analyzing the volume of products they need to sell to achieve profitability. This comparison aids in setting sales targets and assessing the profitability of introducing new products or increasing production.
Traders also employ BEPs in their trades to determine the price at which security must reach to cover all costs associated with the trade, such as taxes, commissions, and management fees. A company’s breakeven point is similarly computed by dividing fixed costs by the gross profit margin percentage.
Benefits of a Breakeven Analysis
A breakeven analysis can help with many things, including:
- Exploring Unforeseen Expenses: A break-even analysis serves as a proactive tool to unearth hidden expenses that might otherwise catch you off guard. By conducting this analysis, you gain insights into your financial commitments, minimizing surprises in the future.
- Emotion-Free Decision Making: Baseless decisions fueled by emotions seldom lead to favorable outcomes in business. Through a break-even analysis, you’re presented with concrete data, enabling you to make rational decisions grounded in facts rather than emotions.
- Goal Setting and Achievement: With a break-even analysis, you gain clarity on the precise goals required to attain profitability. This clear understanding empowers you to establish achievable objectives and progress towards them systematically.
- Facilitating Funding Acquisition: Securing funding often necessitates presenting a comprehensive plan, which includes a break-even analysis. Investors seek assurance and a clear roadmap for profitability, making a breakeven analysis an invaluable tool in demonstrating your business’s financial viability.
- Optimized Pricing Strategies: A break-even analysis guides you in determining optimal pricing strategies for your products or services from a business perspective. By understanding your breakeven point, you can set prices that ensure profitability while remaining competitive in the market.
Stock Market Breakeven Points
Imagine an investor purchases Microsoft stock (MSFT) at $110 per share. At this point, $110 becomes their breakeven threshold for the trade. Any movement in the stock’s price above $110 signifies a profit for the investor, while a drop below $110 indicates a loss. If the price holds steady at $110, the investor remains at the breakeven point, neither gaining nor losing.
For investors grappling with a losing stock position, options present a valuable tool through the option repair strategy. This approach offers avenues to mitigate losses and potentially salvage the investment.
Business Breakeven Points
The breakeven formula for a business provides a dollar figure that is needed to break even. This can be converted into units by calculating the contribution margin (unit sale price less variable costs). Dividing the fixed costs by the contribution margin will reveal how many units are needed to break even.
Business Breakeven=Gross Profit Margin over Fixed Costs
The information required to calculate a business’s BEP can be found in its financial statements. The first pieces of information required are the fixed costs and the gross margin percentage.
Assume a company has $1 million in fixed costs and a gross margin of 37%. Its breakeven point is $2.7 million ($1 million ÷ 0.37). In this breakeven point example, the company must generate $2.7 million in revenue to cover its fixed and variable costs. If it generates more sales, the company will make a profit. If it generates fewer sales, there will be a loss.
It is also possible to calculate how many units need to be sold to cover the fixed costs, which will result in the company breaking even. To do this, calculate the contribution margin, which is the sale price of the product less variable costs.
Assume a company has a $50 sale price for its product and variable costs of $10. The contribution margin is $40 ($50 – $10). Divide the fixed costs by the contribution margin to determine how many units the company has to sell: $1 million ÷ $40 = 25,000 units. If the company sells more units than this, it will show a profit. If it sells fewer, there will be a loss.
What is a breakeven point?
A breakeven point is used in multiple areas of business and finance. In accounting terms, it refers to the production level at which total production revenue equals total production costs. In investing, the breakeven point is the point at which the original cost equals the market price. Meanwhile, the breakeven point in options trading occurs when the market price of an underlying asset reaches the level at which a buyer will not incur a loss.
How do you calculate a breakeven point?
Generally, to calculate the breakeven point in business, fixed costs are divided by the gross profit margin. This produces a dollar figure that a company needs to break even. When it comes to stocks, for example, if a trader bought a stock at $200, and nine months later, it reached $200 again after falling from $250, it would have reached the breakeven point.
How do you calculate a breakeven point in options trading?
Consider the following example in which an investor pays a $10 premium for a stock call option, and the strike price is $100. The breakeven point would equal the $10 premium plus the $100 strike price, or $110. On the other hand, if this were applied to a put option, the breakeven point would be calculated as the $100 strike price minus the $10 premium paid, amounting to $90.
The Bottom Line
A breakeven point tells you what price level, yield, profit, or other metrics must be achieved to not lose any money—or to make back an initial investment on a trade or project. Thus, if a project costs $1 million to undertake, it would need to generate $1 million in net profits before it breaks even.
Calculating breakeven points can be used when talking about a business or with traders in the market when they consider recouping losses or some initial outlay. Options traders also use the technique to figure out what price level the underlying price must be for a trade so that it expires in the money. A breakeven point calculation is often done by also including the costs of any fees, commissions, taxes, and in some cases, the effects of inflation.