Are breakeven calculations always based on how many units, costs etc..it takes to recoup the investment in 1st year? How are these calculations different from pay back period calculations?
I see in breakeven it's typically contribution margin per unit x # of units = Fixed cost, whereas in payback we look at the “additional” profit or cost savings we can have per year x # of years = investment cost.
Did i understand this correctly?
Hi there,
The payback period refers to the time needed to recover an investment.
The breakeven point refers to the situation where total revenues are equal to total costs. The question is normally related to the quantity required to reach that point.
PAYBACK PERIOD
Let’s say that you have the following:
I = Initial investment
CF = Yearly cash flow of the investment
Assume for simplicity that the yearly cash flow is constant and there is no time value of money.
The payback period would be :
Payback period = I / CF
If the cash flow is not constant or there is time value of money, the formula becomes more complex, due to the fact the cash flow changes every year.
BREAKEVEN POINT
Let’s assume your goal is to find the quantity to reach breakeven.
You can just rearrange the breakeven formula, which is the following:
R-VC-FC=0
⇔ p*q-c*q-FC=0
Where
To calculate the quantity, you can rearrange it as follows:
p*q-c*q-FC=0
⇔ q=FC/(p-c)
Hope this helps,
Francesco
Payback period is how long does it take to recover the initial investment.
Breakeven is the revenue (or # of units sold) that will result in no net income or net loss.
Your formulas are generally correct, but I'd rather highlight that you should focus on understanding the concept, not on memorizing the formulas.
Hi there,
Breakeven can be anything!
Just one verison of breakeven is solving for years (i.e. payback).
There are so many breakevens that exist. You may be asked to solve for years, price, quantity, profit, upfront invesment cost, margins, unit cost, variable cost, fixed cost etc.
Learn how to create a breakeven across any scenario and you'll be in a good position!
(edited)
These are 2 different concepts
Payback Period
It is the time taken to pay-off the initial investment through the additional profit generated.
Payback period (X) is defined by years taken for cumulative net cash flow from project C = PV + (C1+C2+C3… per year) such that C becomes just positive - which means that your annual cash flows have finally recovered the initial investment (PV).
Breakeven-point
It is the amount of business you need to do in order to reach a no-profit-no-loss situation. If you do more business than the breakeven point, you will be in profit. If you do less business than breakeven point, you will be in loss.
This sort of thing happens because of fixed costs. When you sell a product, it has a variable cost and hence a gross margin. Beyond this you have fixed costs that are spread across all the units of products you sell.
When you are selling only a small quantity of products, the fixed cost per unit is high and it eats into your gross-margin per product and goes beyond it and gives you a loss.
When you sell more units, the fixed cost per unit is smaller and and less than the gross margin - hence you have a net profit per unit sold.
At the breakeven point - the fixed cost per product is equal to the gross margin per product. Hence you are in a no-profit-no-loss scenario
Hello!
I agree with you that they are related, and until you get them fully you can get confused with them, particularly those of us who didn´t come from an Econ background and saw all the concept at once per case prep.
Payback period, as the name says, is the period, the TIME. Breakeven is the return, and it can be in units, for instance. And it´s true that a breakeven is associated to a time (the time in which it happens, e.g., we break even after the investment in year 3 month 2).
Hope it helps!
Cheers,
Clara
