Break-Even Price

Break-Even Price

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 acquiring and owning it. Another way to compute the total breakeven for a firm is to take the gross profit margin divided by total fixed costs: Business break-even = gross profit margin / fixed costs For an options contract, such as a call or a put, the break-even price is that level in the underlying security that fully covers the option's premium (or cost). To formulate the break-even price, a person simply uses the amount of the total cost of a business or financial activity as the target price to sell a product, service or asset, or trade a financial instrument with the goal to break even. For example, the break-even price of a house would be the sale price at which the owner could cover the home's purchase price, interest paid on the mortgage, hazard insurance, property taxes, maintenance, improvements, closing costs, and real estate sales commissions. In manufacturing, the break-even price is the price at which the cost to manufacture a product is equal to its sale price.

A break-even price describes a change of value that corresponds to just covering one's initial investment or cost.

What Is a Break-Even Price?

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 acquiring 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 manufacturing 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 dispose of the contract without incurring a loss.

A break-even price describes a change of value that corresponds to just covering one's initial investment or cost.
For an options contract, the break-even price is that level in an underlying security when it covers 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 price.
Break-even pricing is often used as a competitive strategy to gain market share, but a break-even price strategy can lead to the perception that a product is of low quality.

Understanding Break-Even Prices

Break-even prices can be applied to almost any transaction. For example, the break-even price of a house would be the sale price at which the owner could cover the home's purchase price, interest paid on the mortgage, hazard insurance, property taxes, maintenance, improvements, closing costs, and real estate sales commissions. At this price, the homeowner would not see any profit, but also would not lose any money.

Break-even price is also used in managerial economics to determine the costs of scaling a product's manufacturing capabilities. Typically, an increase in product manufacturing volumes translates to a decrease in break-even prices because costs are spread over more product quantity.

Traders also use break-even prices to understand where a securities price must go to make a trade profitable after costs, fees, and taxes have been taken into account.

Break-Even Price Formula

The break-even price is mathematically the amount of monetary receipts that equal the amount of monetary contributions. With sales matching costs, the related transaction is said 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 total cost of a business or financial activity as the target price to sell a product, service or asset, or trade a financial instrument 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 cost and variable cost incurred to make the product. Thus if it costs $20 total to produce a good, if it sells for $20 exactly, 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 total fixed costs:

For an options contract, such as a call or a put, the break-even price is that level in the underlying security that fully covers the option's premium (or cost). Also known as the break-even point (BEP), it can be represented by the following formulas for a call or put, respectively:

Break-Even Price Strategy

Break-even price as a business strategy is most common in new commercial ventures, especially if a product or service is not highly differentiated from those of competitors. By offering a relatively low break-even price without any margin markup, a business may have a better chance to gather more market share, even though this is achieved at the expense of making 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 sustain periods of zero earnings. However, after establishing market dominance, a business may begin to raise prices when weak competitors can no longer undermine its higher-pricing efforts.

The following formula can be used to estimate a firm's break-even point:

The break-even point is equal to the total fixed costs divided by the difference between the unit price and variable costs.

Break-Even Price Effects

There are both positive and negative effects of transacting at the break-even price. In addition to gaining market shares and driving away existing competitions, pricing at break-even also helps set an entry barrier for new competitors to enter the market. Eventually, this leads to a controlling market position, due to reduced competition.

However, a product or service's comparably low price may create the perception that the product or service may not be as valuable, which could become an obstacle to raising prices later on. In the event that others engage in a price war, pricing at break-even would not be enough to help gain market control. With racing-to-the-bottom pricing, losses can be incurred when break-even prices give way to even lower prices.

Both marginalist and Marxist theories of the firm predict that due to competition, firms will always be under pressure to sell their goods at the break-even price, implying no room for profits.

Examples of Break-Even Prices

Suppose firm ABC manufactures widgets. The total costs for making a widget per unit can be broken down as follows:

Widget Cost

Direct Labor

Manufacture

Hence, the break-even price to recover costs for ABC is $10 per widget.

Now suppose that ABC becomes ambitious and is interested in making 10,000 such widgets. To do so, it will have to scale operations and make significant capital investments in factories and labor. The firm invests $200,000 in fixed costs, including building a factory and buying machines for manufacturing.

The firm's break-even price for each widget can be calculated as follows:

$30 is the break-even price for the firm to manufacture 10,000 widgets. The break-even price to manufacture 20,000 widgets is $20 using the same formula.

Example: Break-Even Price for an Options Contract

For a call option with a strike price of $100 and a premium paid of $2.50, the break-even price that the stock would have to get to is $102.50; anything above that level would be pure profit, anything below would imply a net loss.

Related terms:

Break-Even Analysis : Analysis Explained

Break-even analysis calculates a margin of safety where an asset price, or a firm's revenues, can fall and still stay above the break-even point. read more

Breakeven Point (BEP)

In accounting and business, the breakeven point (BEP) is the production level at which total revenues equal total expenses.  read more

Call Option

A call option is a contract that gives the option buyer the right to buy an underlying asset at a specified price within a specific time period. read more

Closing Costs

Closing costs are the expenses, beyond the property itself, that buyers and sellers incur to finalize a real estate transaction. read more

Cost-Volume-Profit (CVP) Analysis

Cost-volume-profit (CVP) analysis looks at the impact that varying levels of sales and product costs have on operating profit.  read more

Fixed Cost

A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced or sold. read more

Gross Profit Margin , Formula, & Equation

The gross profit margin is a metric used to assess a firm's financial health and is equal to revenue less cost of goods sold as a percent of total revenue. read more

Hazard Insurance

Hazard insurance protects a property owner against damage caused by fires, severe storms, earthquakes, or other natural events. read more

Operating Leverage

Operating leverage is a cost-accounting formula that measures the degree to which a firm can increase operating income by increasing revenue.  read more

Option Premium

An option premium is the income received by an investor who sells an option contract, or the current price of an option contract that has yet to expire. read more