Break-Even Point: Formula, Calculation, and Why it Matters Break-even analysis involves a calculation of the break-even point (BEP). The break-even point formula divides the total fixed production costs by the price per individual unit less the variable cost per unit. The formula for calculating the break-even point (BEP) involves taking the total fixed costs and dividing the amount by the contribution margin per unit. Your variable costs (or variable expenses) are the expenses that do change with your sales volume. This is the price of raw materials, labor, and distribution for the goods or service you sell. For a coffee shop, the variable costs would be the beans, cups, sleeves, and labor used to produce one cup of coffee. The break-even point formula can determine the BEP in product units or sales dollars. If the company can increase its contribution margin per unit to $8 (by perhaps lowering its per unit variable cost), it only needs to sell 8,750 ($70,000 / $8) to break even. Assume a company has $1 million in fixed costs and a gross margin of 37%. In this breakeven point example, the company must generate $2.7 million in revenue to cover its clearing account fixed and variable costs. The breakeven formula for a business provides a dollar figure that is needed to break even. Contribution Margin Method (or Unit Cost Basis) The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. It is only useful for determining whether a company is making a profit or not at a given point in time. In effect, the insights derived from performing break-even analysis enables a company’s management team to set more concrete sales goals since a specific number to target was determined. Your variable costs (or variable expenses) are the expenses that do change with your sales volume. Sales below the break-even point mean a loss, while any sales made above the break-even point lead to profits. An unprofitable business eventually runs out of cash on hand, and its operations can no longer be sustained (e.g., compensating employees, purchasing inventory, paying office rent on time). Limitations and considerations of break-even analysis Using the algebraic method, we can also identify the break-even point in unit or dollar terms, as illustrated below. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Or, if using Excel, the break-even point can be calculated using the “Goal Seek” function. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. In conclusion, just like the output for the goal seek approach in Excel, the implied units needed to be sold for the company to break even come out to 5k. Importance of Break-Even Point Analysis However, costs may change due to factors such as inflation, changes in technology, and changes in market conditions. It also assumes that there is a linear relationship between costs and production. Break-even analysis ignores external factors such as competition, market demand, and changes in consumer preferences. Break-even analysis compares income from sales to the fixed costs of doing business. In other words, the breakeven point is equal to the total fixed costs divided by the difference between the unit price and variable costs. Note minimum requirements for working as an independent contractor that in this formula, fixed costs are stated as a total of all overhead for the firm, whereas price and variable costs are stated as per unit costs—the price for each product unit sold. When companies calculate the BEP, they identify the amount of sales required to cover all fixed costs before profit generation can begin. Some common fixed costs are your rent payments, insurance payments and money spent on equipment. These costs will stay the same regardless of whether you sell one unit or a million units. The contribution margin represents the revenue required to cover a business’ fixed costs and contribute to its profit. Sales Price per Unit- This is how much a company is going to charge consumers for just one of the products that the calculation is being done for. If you’re a latecomer to a market, there might be too much supply, and you might not be able to break even without economies of scale. However, if you jump on a trend early, you might be able to command market share and price to accelerate toward your break-even point. For instance, if the company sells 5.5k products, its net profit is $5k. After entering the end result being solved for (i.e., the net profit of zero), the tool determines the value of the variable (i.e., the number of units that must be sold) that makes the equation true. Below, we’ll cover everything you need to know about break-even point to calculate your own (with a simple formula) and use it to guide your business toward smarter decisions.
