Let us begin by understanding what break-even price is in trading. The price point at which an investor is neither in profit nor in loss is called a break-even point. The trader would only recover their investment cost. For businesses, the break-even point is when they have recovered all the company’s production, launch, and set-up costs. The company does not make a profit, but it doesn’t incur losses either. This is considered a good stage for businesses since they are closer to making profits.
Break-even price
From an asset sale point of view, a break-even price would be the amount at which you must sell the asset to cover the costs of acquiring, manufacturing, and owning the company. In the stock market, when the investor is not losing any money while selling off their investment, they are selling it at its break-even price.
What is break-even price in other sectors and platforms? The underlying meaning of being able to cover initial costs and reaching a point beyond which you might experience profits remains the same. It is just the material and transactions in the equation that keep changing. An understanding of what is break-even price and how you should evaluate it is very important.
Also read: Trading on equity
Understanding the break-even price
Let us understand what is break-even price with an example. If it costs Rs. 50,000 for you to produce a good and you sell it for exactly Rs. 50,000, you would have made the sale at the good's break-even price without any profits or losses.
Now, let us say you own a real estate property. You would fix the base sale price of the property considering the purchase price or cost of building the place, home insurance, municipal taxes, interest paid on the home loans, and any improvement costs if incurred. Considering all of your expenses on the property, if you sum it up and are only able to sell it for that exact value, then you have managed to sell it at the minimum break-even price point. However, if you included any additional costs in the asking price and managed to sell it, you would have made a profit.
If you rent this property, you might end up paying for the maintenance of the place. In such a case, only when you recover all the expenses via rent deposits, including maintenance costs incurred until that time, would you have reached the break-even point. It might take a while, but after this point, all rent, minus your monthly maintenance charges, will become your profit.
Break-even price formula
To determine the breakeven point in business, the fixed costs are divided by the gross profit margin, which produces a figure that a company needs to break even.
How do you find out what is the break-even price? The formula to calculate this is fixed cost ÷ (revenue - variable costs per unit).
Fixed costs refer to expenses that do not change, regardless of how many units are sold, while revenue is the price at which the product is sold minus the variable costs, such as materials and labour.
Also read: Return on equity (ROE)
Break-even price strategy
Once calculated, it is time to use the value to execute your break-even price strategy. It is commonly used by new ventures to make their way into the market and establish their brand in the sea of competitors and identical products.
This strategy dictates the growth of a company. By sticking to lower price points, brands can attract customers and build a base, so they effectively retain their loyal consumer base even after eventually increasing the price of their product. However, during this phase, they are unable to make any profits and must be prepared to continue with zero earnings. Only once they establish their dominance and beat their competitors can they afford to move past the break-even price and make a profit, increase manufacturing, and expand.
Break-even price effects
Setting the prices at the break-even point has multiple benefits, including being able to acquire market shares and challenging any existing competition. Moreover, it also acts as a gateway for new competitors who might want to enter the market. This eventually leads to a dominant market position as the level of competition is reduced.
There are also significant drawbacks to the service. The public will consider the product or service to be less valuable and perceive it as an average investment option. Increasing prices later becomes difficult as consumers expect a price limit on the trades.
Gaining market control also becomes difficult if you are trading on the break-even price. You cannot reduce the prices and welcome losses, nor increase them too much and lose out on consumers. This kind of price war among manufacturers can lead to racing to the bottom. Depending on what is the break-even price for each producer, at least some manufacturers in the competition end up incurring losses and barely managing to break even to stay in the game.
Also read: Equity share and preference share
Conclusion
Now that you know what break-even price is, use it as a strategy to evaluate the production costs and selling price of your assets. It helps businesses determine when to expand. Only after they reach this break-even price point can bigger leaps be taken without substantial risks, and profits start coming in for the company. Even if you are suffering from a downfall or facing any losses in your business, evaluating and recovering the break-even cost would be ideal if you are to survive in the market or plan to sell your business and disband.
