Financial Breakeven Point
Breakeven means a situation of no gain, no loss. Anything below this level is a loss while the company is at a profit above this level. The financial breakeven point is the amount of EBIT (Earnings before Interest & Tax) where the EPS (Earnings per Share) is equal to zero. In simple words, it is the level of a company’s earnings before it makes payment of interest and tax where it is unable to generate any earnings for its equity shareholders. The financial breakeven calculator will calculate the amount of EBIT where the net income available for equity shareholders is nil.
This is the least amount of EBIT which company requires to meet its fixed financial costs. These fixed financial costs generally include interest and preference dividends. It does not include dividends of equity shareholders as their payment is made only in case when the company earns a profit.
This concept of financial breakeven is quite different from the one we study in costing. Under costing, we calculate the number of units to be sold to reach a no-profit no-loss situation. While here, we calculate the EBIT level at which net income will be nil. However, both focus on covering the fixed costs.
Formula
The formula for calculating the financial breakeven point is as follows:
Financial Breakeven Point = {Preference Dividend / (1 – Tax Rate)} + Interest
Calculator
How to Calculate using Calculator?
Insert the following particulars into the calculator for quickly arriving at the financial breakeven point, that is, the EBIT level where EPS is equal to zero.
Preference Dividend
Enter the total amount of preference dividend due on outstanding preference capital. The rate of the dividend of preference capital is fixed. Therefore, to calculate preference dividend, multiply the rate of dividend by the total outstanding preference capital amount.
Tax Rate
It is the rate by which a portion of the earnings of the company is deducted and paid to the government.
Interest
The amount which the company pays to its debtholder is the interest. The company borrows money from the public as well as financial institutions to finance its daily operations and smooth functioning. Hence, it has to pay the interest to the lenders for providing funds. We calculate this interest on the outstanding amount of borrowings of the company.
Example
Assume that a company has a 12% Preference Capital of $2,000,000 while its interest expense (@10%) equals $200,000. The tax rate under which the company falls is 30%. The company wants to calculate the EBIT for a project where it will be able to meet its fixed financial cost at least.
Total Preference Dividend = 240,000 (i.e., 2,000,000*12%)
Financial Breakeven = {240,000 / (1 – 0.30)} + 200,000 = 542,857.14
Now, assume that company requires additional funds ($360,000) for financing the project and it has three options to raise the funds.
Case 1: 100% equity
Case 2: Equally, through equity and debt
And, Case 3: Equally through equity, debt, and preference capital
Case 1: 100% Equity
The financial breakeven will remain the same in this case as there is no increase in the fixed financial cost of the company. Therefore, financial breakeven is equal to $542,857.14
Also Read: Break Even Point
Case 2: Equally through Equity & Debt
In this case, the amount of interest will increase by 18,000 (i.e., 360,000*50%*10%).
Financial Breakeven = {240,000 / (1 – 0.30)} + 200,000 + 18,000 = 560,857.14
Case 3: Equally through Equity, Debt & Preference Capital
Here, the amount of interest will increase by 12,000 (i.e., 360,000*10%/3) and the preference dividend will increase by 14,400 (360,000*12%/3)
Financial Breakeven = {(240,000+14,400)/ (1 – 0.30)} + 200,000 + 12,000 = 575,428.57
In cases 2 & 3, due to an increase in fixed financial cost, the EBIT has also increased to the extent of an increase in such costs. The company has to earn extra in order to reach this level of breakeven.
