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When companies know their product’s price, and both their fixed and variable costs, but need to know the quantity they must sell or produce to cover expenditures, they turn to the trusted method of performing the break even quantity analysis. Determining a company’s break even quantity isn’t rocket science. If the company has totaled its expenditures, and has determined its product’s pricing, then it’s a simple calculation.
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Understanding a Company’s Total Expenditures
When it comes to totaling a company’s expenditures, it really amounts to summing up the company’s fixed and variable costs. When looking at fixed costs, look at the salaries a company pays its employees, the insurance and rent it pays monthly and any other monthly or yearly expenditures that are consistent over a given period of time. It’s these expenditures that are termed "fixed costs." Variable costs are different in that they vary with usage. For instance, if a company had to hold and purchase higher amounts of inventory in a given month, then its variable costs would rise. Consequently, if it held or purchased less inventory, its variable costs would decline.
Fixed and variable costs are the main players of a company’s total expenditure and are an essential aspect of the break even quantity calculation. Another variable is the price of the product in question. If the company knows its product’s price, and has clearly defined its fixed and variable costs, then the break even quantity calculation simply plugs in values for these variables.
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Critical Steps to Determining the Break Even Quantity
As mentioned, both the company’s fixed and variable costs, as well as the product’s price, are the key variables within the calculation on break even quantity. The critical steps to determining break even quantity is to first total both the company’s fixed and variable costs and second, to use the product’s price within the following calculation.
- Break Even Quantity = BEQ
- Fixed Costs = F = $5000.00
- Variable Costs = C =$400.00
- Price = P= $600.00
- BEQ = F/(P-V)
- BEQ = $5000.00 / ($600.00 - $400.00)
- BEQ = $5000.00 / $200.00
- Break even quantity is 25 units or products
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What Does the Break Even Quantity Analysis Tell Companies?
When companies use the break even analysis on quantity, what’s the first question that comes to mind? Most likely, it involves asking what the company can do to manufacture more or to sell more. This may involve putting forward approaches to increasing the company’s manufacturing capacity, or increasing its sales efforts. The break even quantity is the quantity the company must sell or manufacture to cover costs. It’s important to note that any quantity below 25 units is a loss, and anything above 25 units is a profit. Companies may look at their break even quantity and immediately recognize that it’s an easily attainable quantity to sell or manufacture. Or, it might just cause them to pursue other approaches to increasing their production throughput.
Any decrease in the company’s fixed, or variable costs, will help the company lower the quantity it must sell or manufacture to cover expenditures. Conversely, if the company can increase the price of its products, this too will allow them to reach break even earlier in the process. The break even quantity can be improved but must be tempered with concentrating on the company’s cost structure first, rather than simply raising the product’s price.