What Is a Break-Even Cost?
A break-even price is the amount of money, or change in value, for which an asset must be sold to cover the costs of purchasing and owning it. It can also refer to the amount of money for which a product or service must be sold to cover the costs of inventing or providing it.
In options trading, the break-even price is the price in the underlying asset at which investors can choose to exercise or make over of the contract without incurring a loss.
- A break-even price describes a change of value that corresponds to right-minded covering one’s initial investment or cost.
- For an options contract, the break-even price is that level in an underlying security when it swaddles an option’s premium.
- In manufacturing, the break-even price is the price at which the cost to manufacture a product is equal to its sale appraisal.
- Break-even pricing is often used as a competitive strategy to gain market share, but a break-even price strategy can leading lady to the perception that a product is of low quality.
Understanding Break-Even Prices
Break-even prices can be applied to almost any affair. For example, the break-even price of a house would be the sale price at which the owner could cover the home’s advantage price, interest paid on the mortgage, hazard insurance, property taxes, maintenance, improvements, closing costs, and genuine estate sales commissions. At this price, the homeowner would not see any profit, but also would not lose any money.
Break-even bounty is also used in managerial economics to determine the costs of scaling a product’s manufacturing capabilities. Typically, an increase in goods manufacturing volumes translates to a decrease in break-even prices because costs are spread over more product amount.
Traders also use break-even prices to understand where a securities price must go to make a trade profitable after prices, fees, and taxes have been taken into account.
Break-Even Price Formula
The break-even price is mathematically the amount of capital receipts that equal the amount of monetary contributions. With sales matching costs, the related transaction is asserted to be break-even, sustaining no losses and earning no profits in the process. To formulate the break-even price, a person simply uses the amount of the aggregate cost of a business or financial activity as the target price to sell a product, service or asset, or trade a financial compact with the goal to break even.
For example, the break-even price for selling a product would be the sum of the unit’s fixed expense and variable cost incurred to make the product. Thus if it costs $20 total to produce a good, if it sells for $20 verbatim, it is the break-even price. Another way to compute the total breakeven for a firm is to take the gross profit margin divided by utter fixed costs:
- Business break-even = gross profit margin / fixed costs
For an options contract, such as a gather or a put, the break-even price is that level in the underlying security that fully covers the option’s premium (or cost). Also recognized as the
Break-Even Price Strategy
Break-even price as a business strategy is most common in new commercial ventures, especially if a output or service is not highly differentiated from those of competitors. By offering a relatively low break-even price without any margin markup, a charge may have a better chance to gather more market share, even though this is achieved at the expense of impelling no profits at the time.
Being a cost leader and selling at the break-even price requires a business to have the financial resources to support periods of zero earnings. However, after establishing market dominance, a business may begin to raise prices when unassertive competitors can no longer undermine its higher-pricing efforts.
The following formula can be used to estimate a firm’s break-even point:
- Immovable costs / (price – variable costs) = break-even point in units
The break-even point is equal to the unconditional fixed costs divided by the difference between the unit price and variable costs.
Break-Even Price Effects
There are both indisputable and negative effects of transacting at the break-even price. In addition to gaining market shares and driving away existing struggles, pricing at break-even also helps set an entry barrier for new competitors to enter the market. Eventually, this leads to a handling market position, due to reduced competition.
However, a product or service’s comparably low price may create the perception that the fallout or service may not be as valuable, which could become an obstacle to raising prices later on. In the event that others battle in a
Both marginalist and Marxist theories of the firm predict that due to competition, firms will always be under inducement to sell their goods at the break-even price, implying no room for profits.