The balance point

The balance point, in terms of accounting of costs, is that one point of activity (volume of sales) where the total income are equal to the total costs, that is to say, the point of activity where it does not exist utility nor loss.

To find the balance point is to find the number of units to sell, so that it is fulfilled the previous thing (that the sales are equal to the costs).

And to analyze the balance point is to find the balance point and to analyze this information so that, on the basis of her, to be able to make decisions.

For example, we can find and to analyze the balance point stops:

• to allow one first simulation us that allows to know us from what amount of sales will begin to obtain utilities.
• to know the viability a project, to the knowledge if our demand surpasses our point of balance.
• to see from what level of sales, I could be recommendable to change a Variable Cost by a Fixed Cost or vice versa, for example, to change disposal boards, by a fixed pay in a salesman.
• knowledge that number of units or sales is due to realize, to obtain certain utility.

Steps to find and to analyze the balance point

We see next the steps necessary to find and to analyze our point of balance:

1. To define costs

In the first place we must define our costs, the usual thing is to consider like costs to all the payments, including the expenses of administration and sales, but without including the financial expenses nor to the taxes (method of the total costs).

But when one is a small business, he is preferable to consider like costs to all the total payments of the company, including the financial expenses and the taxes.

2. To classify the costs in Variable Costs (CV) and Fixed Costs (CF)

Once we have determined the costs that we will use to find the balance point, we happened to classify or to divide these in Variable Costs and Fixed Costs:

• Variable costs: they are the costs that vary in agreement with the changes in the activity levels, are related to the number of sold units, volume of production or number of services realized, for example, raw material, combustible, wage per hours, etc.
• Fixed costs: they are costs that are not affected by the variations in the activity levels, for example, rents, depreciation, insurances, etc.

3. To find the unitary variable cost

Thirdly we determined the Unitary Variable Cost (Cvu), which obtains when dividing total the Variable Costs between the number of units produced and sold (q).

It is necessary to find the Cvu because they are the costs that vary with the production.

4. To apply the formula of the balance point

The formula to find the balance point is:

(P x U) - (Cvu x U) - CF = 0

Where:

P: unitary sale price.

U: units of the balance point, that is to say, units to sell so that the income are equal to the costs.

Cvu: unitary variable cost.

CF: fixed costs.

The result of the formula will be in PU, if we want to find the point of balance in monetary units, simply we multiplied the result by the sale price.

5. To verify results

Once found the balance point, we happened to verify the result through use of the Earnings statement.

6. To analyze the balance point

And, finally, once found the point of verified balance and through Earnings statement, we happened to analyze it, for example, to know how much we needed to sell to reach the balance point, how much we must sell to obtain a certain utility, which would be our utility if we sold a certain amount of products, etc.

Example of how finding and analyzing the balance point

We see next a simple example of how to find and to analyze our point of balance:

A company dedicated to the commercialization of shirts, sells shirts to a price of US$40, the cost of each shirt is of US$24, a disposal board by US$2 is pleased, and their fixed expenses (rent, wages, services, etc.), ascend to US$3 500. Which is the point of balance in units of sale and dollars? and to how much they would promote the utilities if 800 shirts were sold?

1. Finding the balance point:

P = 40

Cvu: 24 + 2 = 26

CF = 3500

Applying the formula:

(P x U) - (Cvu x U) - CF = 0

40X - 26X - 3500 = 0

14X = 3500

Qe = 250 und.

Qe = US$10 000

Verifying:

Sales (P x Q): 40 xs 250	10000
(-) C.V (Cvu x Q): 26 xs 250	6500
(-) C.F	3500
Net utility	US$0

Conclusions: our point of balance is of 250 units, that is to say, we needed to sell 250 shirts so that the sales are equal to the costs; therefore, from the sale of 251 shirts, just we would be beginning to obtain utilities.

2. Utilities if we sold 800 shirts:

Sales (P x Q): 40 xs 800	32000
(-) C.V (Cvu x Q): 26 xs 800	20800
(-) C.F	3500
Net utility	US$7700

Conclusions: when selling 250 shirts, our sales would equal our boundaries and, therefore, we would have a utility of 0; but we would sell 800 shirts, we would be obtaining a utility of US$7 700.