When the spending equals the output it is said to be a project or a company is break even. Manufacturing companies or consumer faced businesses depend on the volume produced and sold which reflects the revenue for the year. Since these businesses concentrate only on the units produced and sold, the profit margin sits in the background for a while. Even though the net profit is a gauge of picking a business some businesses stay marginal like automobile producers. Companies that are a natural monopoly, have economies of scale in concern as which maximizes the number of units sold and preserving margin to be said as a sustainable moat.
The break even number of units for a business mainly focuses on the price per unit and the variable cost. Cost that differs according to the number of units produced or the capacity used is said to be variable cost. The raw material is a variable cost.
Debt arises only when the internally generated cash flow is insufficient for the business for a new investment, the existing operation is not as efficient is has to be or shortage of funds where the investment is crucial at the period of time. (Vaccine productions have to start within a month and the research needs to be funded).
The break even quantity for a business is: The total leverage divided by the difference in the price and variable cost.
- Operating cost= $40,000
- Financing cost= $20,000
- Price/ Unit= $4
- Variable cost= $2
(40,000 + 20,000) / (4-2)= 30,000 units. A company with a fixed cost of $40,000 and financing cost of $20,000 needs to sell 30,000 units of its product and more than 30,000 units to profit.
Why not fixed cost is used to calculate break even?
To prevail in the business for the short term, at least the variable cost has to be covered. In a highly competitive market, which demands cutting edge technology will make others to incur a loss as the market price gets lowered by the one who runs an efficient plant, sometimes variable costs will be unable to cover. In this condition the business has to be shut down to minimise losses. In order to stay in business, the variable cost is used. To truly break even, the business has to cover the fixed cost with the existing expenses.
- Fixed cost= $1
The break even is now increased to 60,000 units. (60,000/ 4-2-1)