What Is A Break-Even Point?
The most understood definition for the break-even point is when your revenues minus all of your expenses equal zero. Three different break-even point methods will be outlined in this article.
Break-Even Point in Units
The first way to calculate the break-even point is by determining the number of sales units that need to be sold for your sales to equal your expenses.
Break-Even Point in Revenue
The second method in establishing the break-even point is calculating the revenue in sales dollars that have to be sold to equal your expenses.
Profit Break-Even Point
The number of units or revenue that must be reached to cover all of your costs to meet your business's profit goal. This method should be used if the company has set profit expectations.
Before you can start to calculate the break-even point for your business, there is the terminology that you need to understand.
Variable costs are those expenses that increase or decrease with sales. These are typically the cost of goods and cost of sales items and will differ based on the business type. Typical variable costs would include: purchases, freight-in, sales commissions, and labour used in the making of products, to name a few.
Fixed costs are typically the operating expenses on your income statement. Fixed costs will not change no matter how many units you sell or how much revenue you make. Examples of fixed costs are rent, supplies, salaries, depreciation. There are some costs that most businesses treat as fixed, but dependent on your industry, it may very well be variable component as well. Example: In a manufacturing business where utilities vary greatly due to the product being produced, the business might make the portion of utilities in the manufacturing area a variable cost. Utilities in this case would be a mixed cost.
Contribution Margin Per Unit
The contribution margin per Unit is the Unit's sales price – costs per Unit (variable).
Contribution Margin Per Unit = Sales Price Per Unit – Cost Per Unit (Variable)
Example: If your sales were $100,000 and your costs and $50,000 were your variable costs, and you sold 10,000 units.
Contribution Margin Per Unit = ($100,000/10,000) - ($50,000/10,000) or $5 per unit
Price Per unit = $100,000/$10,000 = $10 per unit
Cost Per unit = $50,000/ $10,000 = $5 per unit
The contribution margin is revenue minus variable costs.
Contribution Margin (Sales) = Revenue – Variable Costs
Example: If your sales were $100,000 and your variable costs were $50,000
Contribution Margin = $100,000 - $50,000 = $50,0000
Contribution Margin Ratio
The contribution margin ratio is the contribution margin divided by sales.
Contribution Margin Ratio = Contribution Margin / Revenue
Example. If your contribution margin was $50,000 and your sales were $100,000
Contribution Margin Ratio = $50,000 / $100,000 = .5
Calculating Your Break-Even Point in Units
To calculate your break-even points in units, you need to understand your fixed costs and contribution margin per Unit.
In the example above, the contribution margin per unit is $5. The fixed costs on the income statement are $25,000.
Break-Even Point in Units = Fixed Costs / Contribution Margin Per Unit
Break-Even Point in Units = $25,000 / $5= 5000 units that are required
5000 Units * 10 = $50,000
5000 Units * 5 = $25,000
Fixed Costs = $25,000
Sales (units) – Costs(units) – Fixed Costs = $0
Calculating Your Break-Even Point in Revenue
To calculate the break-even point in revenue, you need to understand your fixed costs and contribution margin ratio.
In the example above, the contribution margin ratio is .5. The fixed costs on the income statement are $25,000.
Break-Even Point in Revenue = Fixed Costs / Contribution Margin Ratio
Break-Even Point in Revenue = $25,000 / .5 = $50,000
$50,000 (BEP) – Variable Costs ($25,000) – Fixed Costs ($25,000) = $0
Calculating Your Profit Break-Even Point
To calculate your profit break-even point, you will need to set your profit goal. If you want the business in the example above to make $$120,000 in profit for the year, you can then calculate the number of units you will need to sell and the revenue point you need to achieve your goal.
Information from the example above :
Fixed Costs = $25,000
Price Per Unit = $10
Selling Price Per Unit = $5
Contribution Margin Ratio = .5
Profit Goal = $120,000
Profit Unit Break-Even Point = Fixed Costs + Profit Objective / Price (Unit)– Selling Price (Unit)
Profit Unit Break-Even Point = $25,000 + $120,000 / $10-$5 = 29,000 units
29,000 Units * 10 = $290,000
29,000 Units * 5 = $ 145,000
Fixed Costs = $25,000
Sales (units) – Costs(units) – Fixed Costs = $120,000 in profit
Profit Revenue Break-Even Point = Fixed Costs + Profit Objective / Contribution Margin
Profit Revenue Break-Even Point = $25,000 + $120,000 / .5 = $290,000
Why Knowing Your Break-Even is Important
Understanding your break-even point can help you manage many aspects of your business. It enables you to understand your fixed and variable costs and their effects on your profit. It can help you forecast and budget properly by determining how many units and sales you need to make to hit your forecasted revenue goals. Knowing your break-even point can help you monitor both variable and fixed costs and understand the impact of making changes to your unit sales prices on your overall revenue and profit.
When your business is looking for financing, the break-even point is a calculation that a lender or investor will use to determine whether your business is worth taking a risk.
Bottom line, as a business owner, break-even analysis is an essential financial tool in helping you manage your business.