Calculating Break Even Point with Depreciation

The break even point is the point at which total revenue equals total costs, including depreciation. Calculating this with depreciation requires understanding both accounting principles and financial mathematics.

What is Break Even Point?

The break even point is the sales volume at which a company's total revenue equals its total costs. This is a critical financial metric that helps businesses understand how many units they need to sell to cover all expenses and start making a profit.

When calculating break even with depreciation, we account for the systematic reduction in the value of an asset over time. This is particularly important for businesses that own physical assets like machinery or buildings.

The Formula

The basic break even point formula is:

Break Even Point = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)

When including depreciation, the formula becomes more complex because we need to account for the time value of money and the asset's useful life.

Break Even Point with Depreciation =
(Fixed Costs + Depreciation Expense) / (Selling Price per Unit - Variable Cost per Unit)

Where depreciation expense is calculated as:

Depreciation Expense = (Asset Cost - Salvage Value) / Useful Life

How Depreciation Affects Break Even

Depreciation represents the allocation of the cost of a tangible asset over its useful life. This affects the break even calculation because it increases the total costs that must be covered by revenue.

For example, a company purchasing equipment for $10,000 with a salvage value of $1,000 and a useful life of 5 years would have annual depreciation of $1,800 ($9,000 / 5). This $1,800 must be covered by revenue each year.

Note: Depreciation methods can vary (straight-line, declining balance, etc.), but straight-line is most commonly used for break even calculations unless specified otherwise.

Worked Example

Let's calculate the break even point for a company with the following details:

Item	Value
Fixed Costs	$50,000
Variable Cost per Unit	$20
Selling Price per Unit	$40
Asset Cost	$10,000
Salvage Value	$1,000
Useful Life (years)	5

First, calculate annual depreciation:

Depreciation = ($10,000 - $1,000) / 5 = $1,800/year

Now, calculate the break even point:

Break Even Point = ($50,000 + $1,800) / ($40 - $20) = $51,800 / $20 = 2,590 units

This means the company needs to sell 2,590 units to cover all costs including depreciation.

FAQ

What is the difference between fixed and variable costs in break even analysis?

Fixed costs are expenses that don't change with production volume (like rent or salaries), while variable costs vary directly with production (like materials or labor per unit). Depreciation is typically treated as a fixed cost in break even calculations.

How does inflation affect break even point calculations?

Inflation can increase both fixed and variable costs over time. To account for this, you should use current year cost estimates or apply an inflation factor to your base year numbers.

Can I use this calculator for service businesses?

Yes, service businesses can use this calculator by treating their fixed costs (like overhead) and variable costs (like labor per service) appropriately. Depreciation would apply to any physical assets they own.