Break-Even Point Analysis Can Help You Manage Your Business

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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.

Terminology

Before you can start to calculate the break-even point for your business, there is the terminology that you need to understand.

Variable Costs

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

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

Contribution Margin

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