Breakeven (or break even) is the point of balance between making either a profit or a
loss. The term originates in finance, but the concept has been applied widely since.
Contents
[hide]
1 In economics
2 In finance
3 In other fields
4 References
In economics[edit]
Main article: Breakeven (economics)
In economics & business, specifically cost accounting, the breakeven point (BEP) is the
point at which cost or expenses and revenue are equal: there is no net loss or gain, and one
has "broken even." A profit or a loss has not been made, although opportunity costs have
been "paid," and capital has received the riskadjusted, expected return.
[1]
It is shown
graphically as the point where the total revenue and total cost curves meet. In the linear case
the breakeven point is equal to the fixed costs divided by the contribution margin per unit.
In finance[edit]
The accounting method of calculating breakeven point does not include cost of working
capital. The financial method of calculating breakeven, called value added breakeven
analysis, is used to assess the feasibility of a project. This method not only accounts for all
costs, it also includes the opportunity costs of the capital required to develop a project.
[2]
In other fields[edit]
In nuclear fusion research, the term breakeven refers to a fusion energy gain factor equal to
unity, this is also known as the Lawson criterion.
The notion can also be found in more general phenomena, such as percolation, and is rather
similar to the critical threshold. In energy, the breakeven point is the point where usable
energy gotten from a process exceeds the input energy.
In computer science, the (less usual) term refers to a point in the life cycle of a programming
language where the language can be used to code its own compiler or interpreter. This is also
called selfhosting.
In music and media it is a song by the band The Script.
In medicine, it is a postulated state when the advances of medicine permit every year an
increase of one year or more of the life expectancy of the living, therefore leading to medical
immortality
[3]
(barring accidental death).
In Gambling, when one has gained and then lost, or lost and then gained, returning to the
amount of money they had upon commencement and walks away, they are said to have
broken even.
Profitability Ratios
Net Profit:
Net profit ratio is a popular profitability ratio that shows
relationship between net profit after tax and sales. It computed by
dividing the net profit after tax by net sales.
Net Profit Ratio =
Net Profit after Tax/Net Sales*100
Net profit ratio (NP ratio) is a popular profitability ratio that
shows relationship between net profit after tax and net sales. It is computed by dividing the
net profit (after tax) by net sales.
Formula:
For the purpose of this ratio, net profit is equal to gross profit minus operating expenses and
income tax. All nonoperating revenues and expenses are not taken into account because the
purpose of this ratio is to evaluate the profitability of the business from its primary
operations. Examples of nonoperating revenues include interest on investments and income
from sale of fixed assets. Examples of nonoperating expenses include interest on loan and
loss on sale of assets.
The relationship between net profit and net sales may also be expressed in percentage form.
When it is shown in percentage form, it is known as net profit margin. The formula of net
profit margin is written as follows:
Example:
Sales $ 210,000
Returns inwards
10,000
Gross profit
80,000
Administrative expenses
15,000
Selling expenses
15,000
Interest on investment
10,000
Loss on account of fire
6,000
Income tax
5,000
Net profit ratio would be computed as follows:
= ($45,000* / 200,000**)
= 0.225 or 22.5%
*Computation of net operating profit after tax:
Gross profit
80,000
Less operating expenses:
Administrative expenses 15,000
Selling expenses 15,000 30,000
 
Net operating profit before tax
50,000
Less income tax
5,000

Net operating profit after tax
45,000

Note: Interest on investment and loss on account of fire has been ignored because interest
on investment is a nonoperating income and loss on account of fire is a nonoperating loss.
** Computation of net sales:
210,000 10,000 = 200,000
Significance and Interpretation:
Net profit (NP) ratio is a useful tool to measure the overall profitability of the business. A
high ratio indicates the efficient management of the affairs of business.
There is no norm to interpret this ratio. To see whether the business is constantly improving
its profitability or not, the analyst should compare the ratio with the previous years ratio, the
industrys average and the budgeted net profit ratio.
The use of net profit ratio in conjunction with the assets turnover ratio helps in ascertaining
how profitably the assets have been used during the period.
Gross profit ratio (GP ratio) is a profitability ratio that shows the relationship between
gross profit and total net sales revenue. It is a popular tool to evaluate the operational
performance of the business . The ratio is computed by dividing the gross profit figure by net
sales.
Formula:
The following formula/equation is used to compute gross profit ratio:
When gross profit ratio is expressed in percentage form, it is known as gross profit margin or
gross profit percentage. The formula of gross profit margin or percentage is given below:
The basic components of the formula of gross profit ratio (GP ratio) are gross profit and
net sales. Gross profit is equal to net sales minus cost of goods sold. Net sales are equal to
total gross sales less returns inwards and discount allowed. The information about gross
profit and net sales is normally available from income statement of the company.
Example:
The following data relates to a small trading company. Compute the gross profit ratio (GP
ratio) of the company.
Gross sales $ 1,000,000
Sales returns
90,000
Opening stock
200,000
Purchases
590,000
Purchases returns
70,000
Closing stock
45,000
Solution:
With the help of above information, we can compute the gross profit ratio as follows:
= (235,000 / 910,000)
= 0.2582 or 25.82%
The GP ratio is 25.82%. It means the company may reduce the selling price of its products by
25.82% without incurring any loss.
*Computation of gross profit:
Sales
1,000,000
Less sales returns
90,000

Net sales
910,000
Less cost of goods sold:
Opening inventory
200,000
Purchases 590,000
Purchases returns 70,000 520,000
 
Available for sale
720,000
Less closing inventory
45,000 675,000
 
Gross profit
235,000

Significance and interpretation:
Gross profit is very important for any business. It should be sufficient to cover all expenses
and provide for profit.
There is no norm or standard to interpret gross profit ratio (GP ratio). Generally, a higher
ratio is considered better.
The ratio can be used to test the business condition by comparing it with past years ratio and
with the ratio of other companies in the industry. A consistent improvement in gross profit
ratio over the past years is the indication of continuous improvement . When the ratio is
compared with that of others in the industry, the analyst must see whether they use the same
accounting systems and practices.
Return on capital employed ratio is computed by dividing the net income before
interest and tax by capital employed. It measures the success of a business in generating
satisfactory profit on capital invested. The ratio is expressed in percentage.
Formula:
The basic components of the formula of return on capital employed ratio are net income
before interest and tax and capital employed.
Net income before interest and tax (Operating income):
Net income before the deduction of interest and tax expenses is frequently referred to as
operating income. Here, interest means interest on long term loans. If company pays interest
expenses on shortterm borrowings, that is deducted to arrive at operating income.
Capital employed:
Capital employed is calculated in a number of ways. Some popular methods are given below:
1. Total of fixed and current assets.
2. Total of fixed assets only.
3. Fixed assets plus working capital.
4. Total of long term funds. Long term funds include capital, Reserve and surplus etc.
In managerial accounting, the last method is usually used to calculate capital employed.
Example:
Fixed assets $ 800,000
Current assets
300,000
Longterm investment
200,000
Share capital
600,000
8% bonds
400,000
Reserves
200,000
Accounts payable
100,000
Net income before interest and tax
100,000
Interest on longterm investments
20,000
From the above information, we can compute the return on capital employed ratio as
follows:
= (80,000* / 1,000,000**) 100
= 8%
*Computation of net profit before interest and tax:
Net income before interest and tax Interest on long term investment
$100,000 $20,000 = $80,000
**Computation of capital employed:
Fixed assets + Current assets Current liabilities
$800,000 + $300,000 $100,000 = $1,000,000
Significance and Interpretation:
Return on capital employed ratio measures the efficiency with which the investment made by
shareholders and creditors is used in the business. Managers use this ratio for various
financial decisions. It is a ratio of overall profitability and a higher ratio is, therefor, better.
To see whether the business has improved its profitability or not, the ratio can be calculated
for a number of years.
Classification of financial ratios on the basis of function:
On the basis of function or test, the ratios are classified as liquidity ratios, profitability ratios,
activity ratios and solvency ratios.
Liquidity Ratios:
Liquidity ratios measure the adequacy of current and liquid assets and help evaluate the
ability of the business to pay its shortterm debts. The ability of a business to pay its short
term debts is frequently referred to as shortterm solvency position or liquidity position of
the business.
Generally a business with sufficient current and liquid assets to pay its current liabilities as
and when they become due is considered to have a strong liquidity position and a businesses
with insufficient current and liquid assets is considered to have weak liquidity position.
Shortterm creditors like suppliers of goods and commercial banks use liquidity ratios to
know whether the business has adequate current and liquid assets to meet its current
obligations. Financial institutions hesitate to offer shortterm loans to businesses with weak
shortterm solvency position.
Four commonly used liquidity ratios are given below:
1. Current ratio or working capital ratio
2. Quick ratio or acid test ratio
3. Absolute liquid ratio
4. Current cash debt coverage ratio
Unfortunately, liquidity ratios are not true measure of liquidity because they tell about the
quantity but nothing about the quality of the current assets and, therefore, should be used
carefully. For a useful analysis of liquidity, these ratios are used in conjunction with activity
ratios (also known as current assets movement ratios). Examples of activity ratios
are receivables turnover ratio, accounts payable turnover ratioand inventory turnover
ratio etc.
Profitability ratios:
Profit is the primary objective of all businesses. All businesses need a consistent
improvement in profit to survive and prosper. A business that continually suffers losses
cannot survive for a long period.
Profitability ratios measure the efficiency of management in the employment of business
resources to earn profits. These ratios indicate the success or failure of a business enterprise
for a particular period of time.
Profitability ratios are used by almost all the parties connected with the business.
A strong profitability position ensures common stockholders higher dividend income and
appreciation in the value of the common stock in future.
Creditors, financial institutions and preferred stockholders expect a prompt payment of
interest and fixed dividend income if the business has good profitability position.
Management needs higher profits to pay dividends and reinvest a portion in the business to
increase the production capacity and strengthen the overall financial position of the
company.
Some important profitability ratios are given below:
1. Net profit (NP) ratio
2. Gross profit (GP) ratio
3. Price earnings ratio (P/E ratio)
4. Operating ratio
5. Expense ratio
6. Dividend yield ratio
7. Dividend payout ratio
8. Return on capital employed ratio
9. Earnings per share (EPS) ratio
10. Return on shareholders investment/Return on equity
11. Return on common stockholders equity ratio
Activity ratios:
Activity ratios (also known as turnover ratios) measure the efficiency of a firm or company
in generating revenues by converting its production into cash or sales. Generally a fast
conversion increases revenues and profits.
Activity ratios show how frequently the assets are converted into cash or sales and, therefore,
are frequently used in conjunction with liquidity ratios for a deep analysis of liquidity.
Some important activity ratios are:
1. Inventory turnover ratio
2. Receivables turnover ratio
3. Average collection period
4. Accounts payable turnover ratio
5. Average payment period
6. Asset turnover ratio
7. Working capital turnover ratio
8. Fixed assets turnover ratio
Solvency ratios:
Solvency ratios (also known as longterm solvency ratios) measure the ability of a business
to survive for a long period of time. These ratios are very important for stockholders and
creditors.
Solvency ratios are normally used to:
Analyze the capital structure of the company
Evaluate the ability of the company to pay interest on long term borrowings
Evaluate the ability of the the company to repay principal amount of the long term loans (debentures,
bonds, medium and long term loans etc.).
Evaluate whether the internal equities (stockholders funds) and external equities (creditors funds)
are in right proportion.
Some frequently used longterm solvency ratios are given below:
1. Debt to equity ratio
2. Times interest earned (TIE) ratio
3. Proprietary ratio
4. Fixed assets to equity ratio
5. Current assets to equity ratio
6. Capital gearing ratio
Classification on the basis of financial statements:
Income statement/profit and loss ratios:
Income statement/profit and loss account ratios are those ratios that are calculated by using
the items of income statement/profit and loss account of a particular period only. Examples
of income statement/profit and loss account ratios are net profit ratio, gross profit ratio,
operating ratio, and times interest earned ratio etc.
Balance sheet ratios:
Balance sheet ratios are those ratios that are calculated by using figures from the balance
sheet only. The figures must be used from the balance sheet of the same period. Examples of
balance sheet ratios are current ratio, liquid ratio, and debt to equity ratio etc.
Composite ratios:
These ratios are calculated by using the items of both income statement and balance sheet
for the same period. Composite ratios are, therefore, also known as mixed ratios and
interstatement ratios. Numerous composite ratios are computed depending on the need of
analyst. Some examples are inventory turnover ratio, receivables turnover ratio, accounts
payable turnover ratio, and working capital turnover ratio etc.
Classification on the basis of importance:
On the basis of importance or significance, the ratios are classified as primary ratios and
secondary ratios. The most important ratios are called primary ratios and less important
ratios are called secondary ratios. Secondary ratios are usually used to explain the primary
ratios.
Examples of primary ratios for a commercial undertaking are return on capital employed
ratio and net profit ratio because the basic purpose of these undertakings is to earn profit.
Importance of ratios significantly varies among industries therefore each industry has its
own primary and secondary ratios. A ratio that is of primary importance in one industry may
be of secondary importance in another industry.
Classification of ratios on the basis of importance or significance is very useful for interfirm
comparisons.