What Is the Breakeven Point (BEP)?
The breakeven point (breakeven price) for a trade or investment is determined by comparing the market price of an asset to the original cost; the breakeven point is reached when the two prices are equal.
In corporate accounting, the breakeven point (BEP) formula is determined by dividing the total fixed costs associated with production by the revenue per individual unit minus the variable costs per unit. In this case, fixed costs refer to those that do not change depending upon the number of units sold. Put differently, the breakeven point is the production level at which total revenues for a product equal total expenses.
- In accounting, the breakeven point is calculated by dividing the fixed costs of production by the price per unit minus the variable costs of production.
- The breakeven point is the level of production at which the costs of production equal the revenues for a product.
- In investing, the breakeven point is said to be achieved when the market price of an asset is the same as its original cost.
- A breakeven analysis can help with finding missing expenses, limiting decisions based on emotions, establishing goals, securing funding, and setting appropriate prices.
Understanding Breakeven Points (BEPs)
Breakeven points (BEPs) can be applied to a wide variety of contexts. For instance, the breakeven point in a property would be how much money the homeowner would need to generate from a sale to exactly offset the net purchase price, inclusive of closing costs, taxes, fees, insurance, and interest paid on the mortgage—as well as costs related to maintenance and home improvements. At that price, the homeowner would exactly break even, neither making nor losing any money.
Traders also apply BEPs to trades, figuring out what price a security must reach to exactly cover all costs associated with a trade, including taxes, commissions, management fees, and so on. A company’s breakeven point is likewise calculated by taking fixed costs and dividing that figure by the gross profit margin percentage.
Benefits of a Breakeven Analysis
A breakeven analysis can help with many things, including:
- Finding missing expenses. A breakeven analysis can help uncover expenses that you otherwise might not have seen coming. Your financial commitments will be determined at the end of a breakeven analysis, so there won’t be any surprises down the line.
- Limiting decisions based on emotions. Making business decisions based on emotions is rarely a good idea, but it can be hard to avoid. A breakeven analysis leaves you with hard facts, which is a better viewpoint from which to make business decisions.
- Setting goals. You will know exactly what kind of goals need to be met to make a profit after a breakeven analysis. This helps you set goals and work toward them.
- Securing funding. Often, you will need to use a breakeven analysis to secure funding and show investors the plan for your business.
- Pricing appropriately. A breakeven analysis will show you how to properly price your products from a business standpoint.
Stock Market Breakeven Points
Assume an investor buys Microsoft stock (MSFT) at $110. That is now their breakeven point on the trade. If the price moves above $110, the investor is making money. If the stock drops below $110, they are losing money.
If the price stays right at $110, they are at the BEP, because they are not making or losing anything.
Options Trade Breakeven Points
Call Option Breakeven Point Example
For options trading, the breakeven point is the market price that an underlying asset must reach for an option buyer to avoid a loss if they exercise the option. For a call buyer, the breakeven point is reached when the underlying asset is equal to the strike price plus the premium paid, while the BEP for a put position is reached when the underlying asset is equal to the strike price minus the premium paid. The breakeven point doesn’t typically factor in commission costs, although these fees could be included if desired.
Assume that an investor pays a $5 premium for an Apple stock (AAPL) call option with a $170 strike price. This means that the investor has the right to buy 100 shares of Apple at $170 per share at any time before the options expire. The breakeven point for the call option is the $170 strike price plus the $5 call premium, or $175. If the stock is trading below this, then the benefit of the option has not exceeded its cost.
If the stock is trading at $190 per share, the call owner buys Apple at $170 and sells the securities at the $190 market price. The profit is $190 minus the $175 breakeven price, or $15 per share.
Put Option Breakeven Point Example
Assume an investor pays a $4 premium for a Meta (formerly Facebook) put option with a $180 strike price. That allows the put buyer to sell 100 shares of Meta stock (META) at $180 per share until the option’s expiration date. The put position’s breakeven price is $180 minus the $4 premium, or $176. If the stock is trading above that price, then the benefit of the option has not exceeded its cost.
If the stock is trading at a market price of $170, for example, the trader has a profit of $6 (breakeven of $176 minus the current market price of $170).
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 provide how many units are needed to break even.
Business Breakeven=Gross Profit MarginFixed 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 have 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 metric 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.