Accounting breakeven point definition
/What is the Accounting Breakeven Point?
The accounting breakeven point is the sales level at which a business generates exactly zero profits, given a certain amount of fixed costs that it must pay for in each period. This concept is used to model the financial structure of a business. If the breakeven point is too high, then a business may not be able to ever earn a profit, especially when its maximum capacity level is the same as or less than its breakeven point.
The calculation of the accounting breakeven point is a three-step process, which is described below.
Step 1. Determine Contribution Margin
Determine the contribution margin generated by all of the company's products in aggregate. This is net sales minus all variable costs associated with those sales (which is at least direct materials and commissions). Thus, if a business has sales of $1,000,000, direct materials costs of $280,000, and commissions of $20,000, its contribution margin is $700,000 and its contribution margin percentage is 70%.
Step 2. Determine Fixed Costs
Calculate the total amount of fixed costs that the business incurs in an accounting period, such as for rent, salaries, and interest expense.
Step 3. Calculate Breakeven Point
Divide the total fixed cost by the contribution margin percentage to arrive at the breakeven sales point. In our continuing example, this means that having fixed costs of $500,000 results in a breakeven sales level of $714,285 (calculated as $500,000 of fixed costs divided by the 70% contribution margin).
If we assume that the "accounting" breakeven point refers to the accrual basis of accounting, then the fixed cost portion of the breakeven calculation should include all expense accruals normally required under the accrual basis of accounting. Alternatively, you could develop a "cash" breakeven point where the fixed cost portion of the calculation only includes costs recorded under the cash basis of accounting.
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The Difference Between Accounting Breakeven and Cash Breakeven
If you were to develop a separate accounting breakeven point and a cash breakeven point for a business, they would likely reveal somewhat different sales breakeven points, since the timing of expense recognition is different under the two methods. Generally speaking, the accounting breakeven point would be less likely to change from period to period than the cash breakeven point, since the accrual basis tends to result in the more consistent recognition of sales and expenses from period to period. Over the long term, there would be only a minimal difference between the accounting and cash breakeven points, since any differences tend to cancel each other out over time.