Contribution and Break-Even Point (BEP)

Reviewed by Subject Matter Experts

Updated on March 30, 2023

Contribution

The term contribution refers to the excess of selling price over a product's variable cost. Thus, contribution is the difference between the sale price and variable cost. In other words:

Contribution (C) = Sales - Variable cost (or Fixed cost) + Profit

Example

Suppose that sales are \$80,000, variable cost is \$40,000, and fixed cost amounts to \$30,000. Using this information to calculate contribution, it follows that:

Contribution = Sales - Variable cost

= \$80,000 - \$40,000

= \$40,000

Usefulness of Contribution

Contribution is useful for a company's management in the following ways:

1. When calculating BEP: At the break-even point (BEP), sales values and total costs are equal. Excess output over BEP output will result in profit.

2. Provides information about desired profit: Profit happens when the contribution exceeds the fixed costs. The amount of profit that a company aims to earn depends on its cost of capital.

The BEP is a no-profit no-loss area, where the desired profit is represented as an addition over the BEP.

To calculate profit based on contribution and fixed costs, the formula is:

Profit = Contribution - Fixed costs

3. Selection of best alternative: The concept of contribution helps to evaluate alternative proposals (e.g., whether to change the sales mix or enter an overseas market).

Break-Even Point (BEP)

The break-even point, or BEP, is the point at which the cost incurred and the revenues generated are equal. It is also known as zero-point costs. Excess output and sales over BEP is an indicator of profit.

The formula for BEP is as follows:

BEP sales = Fixed expenses + Variable costs

BEP in units: Fixed expenses \$80,000 sale price per unit \$20, variable cost \$15. Thus BEP (Units)

BEP= Fixed expenses / C

= 80,000 / 5

= 16,000 units

Verification

 Sales value = 16,000 units x 20 \$320,000 Variable cost = 16,000 x 15 240,000 Fixed cost 80,000 Total cost 320,000 (0) Zero

BEP (Sales) = BEP units x Per unit sale

= 16,000 x 20

= \$320,000

Usefulness of Break-Even Point (BEP)

The break-even point (BEP) is used in the following main ways:

1. Knowledge of profitability: The BEP offers information about the profitability of specific products.

2. Helpful in changing sales price: The BEP is useful in changing sales price and its effects on business.

3. Desired profit: The BEP is useful in knowing the amount of desired profits.

4. Useful for expansion: The BEP is helpful in learning about the expansion possibilities of the business.

5. Useful for knowledge about profit or loss on different levels of output: BEP provides clear data about profit and loss. When sales exceed the BEP, profit is possible; when sales are lower than the BEP sales, losses are probable.