How to Calculate Break Even Point and margin of safety?

The break- even point is a point of sales of a company wherein total sales covers exactly its total costs. In the other words break even point is the point of zero loss or profit.It means profit is zero at the  break- even point of sales. The company earns  the profit if the sales grow beyond break-even point, and it incurs loss if the sales do not reach the break-even point. To findout breakeven point of the company’s production we need to know three variables viz.Fixed cost, variable cost and selling price of the product.

Fixed Cost: The company has to meet its overhead expenses, irrespective of the volume of production and the sales. This expense is fixed and does not change proportionately to sales. Therefore it is named as fixed cost.

Variable Cost:  Variable costs are those expense which changes with the level of sales.

Selling price: The company fixes the  price of each unit at  the wholesale rate at which it sells its product to its customers/distributors, taking into account of the manufacturing cost of the product, selling expenses and profit margin. The break-even point of sales can be calculated by the following formula if we know fixed cost, variable cost and price of the product.

Number units to be sold for Break Even point is Fixed Cost÷ (Price-Variable Costs) i.e. X =FC÷ (P-V)
wherein X is the total number of units to be sold, P is the price of the unit, FC is the Fixed Cost,V is the variable cost per unit.

Let us take an example of sales fixed expenses of a company is Rs.4800000, the unit price of the product is Rs.10 and variable cost is Rs.2 per unit. Now we know the formula to find out the number of units to be sold to reach BEP.

The minimum number of units required to be produced  and sold to get get break even point is X=FC÷ (P-V)= 4800000÷(10-2)=4800000÷8=600000 units.
The company has to sell the minimum of  600000 units at a price of Rs.10 per unit to to meet Fixed cost of Rs.4800000 plus variable cost of Rs.1200000 to reach  the break-even point.

Illustration 2: (2nd method of calculating BEP)

Let us assume a company’s sales are Rs.10000000 @ Rs.10 per unit. Its fixed cost is Rs.4800000 and variable cost is 2000000.

Now we have to  first calculate contribution i.e. 10000000-2000000=8000000 (Contribution means Sales minus variable cost), then have to find out PV ratio (Profit volume ratio)

 P/V ratio =contribution x100/sales= 8000000×100/10000000= 80%

BEP=Fixed cost/PV ratio,= 4800000/80%= 6000000

The company has to sell the minimum of  600000 units at a price of Rs.10 per unit to to meet Fixed cost of Rs.4800000 plus variable cost of Rs.1200000 (i.e.600000×2) to reach  the break-even point.

Margin of safety (MOS) is the difference between actual sales and break even sales. In other words, all sales revenue above the break-even point represents the margin of safety.

In the above example, Actual sale is is Rs.10000000/-, Break Even Point of sale is Rs.6000000/- then margin of safety Rs.4000000/-

Related article:

What is profit volume ratio (P/V ratio)?