Calculating the break-even point is a key financial analysis tool used by business owners. Once you know the fixed and variable costs for the product your business produces or a good approximation of them, you can use that information to calculate your company’s breakeven point.
What Is the Break-Even Point?
The break-even point, or break-even quantity, is the number of units a company needs to sell in order to earn $0 and lose $0. The definition of the break-even point is that it is the number of sales where the company has enough money to pay for all its expenses, but not enough money to keep anything and make a profit.
It’s important for companies to know this because then they can calculate how much they need to sell in order to “break-even” and neither lose nor gain. Anything they sell above the break-even point is profit (money earned after expenses), and anything below it is a loss (spending that exceeds revenue).
How to use a break-even analysis
A break-even analysis allows you to determine your break-even point. But this isn’t the end of your calculations. Once you crunch the numbers, you might find that you have to sell a lot more products than you realized to break even.
At this point, you need to ask yourself whether your current plan is realistic, whether you need to raise prices, find a way to cut costs, or both. You should also consider whether your products will be successful in the market. Just because the break-even analysis determines the number of products you need to sell, there’s no guarantee that they will sell.
Ideally, you should conduct this financial analysis before you start a business so you have a good idea of the risk involved. In other words, you should figure out if the business is worth it. Existing businesses should conduct this analysis before launching a new product or service to determine whether or not the potential profit is worth the startup costs.
Calculating the Break-Even Point
Break-Even Point: Number of units that must be sold in order to produce a profit of zero (but will recover all associated costs). In other words, the break-even point is the point at which your product stops costing you money to produce and sell, and starts to generate a profit for your company.
- setting price level and its sensitivity
- targeting the “best” values for the variable and fixed cost combinations
- determining the financial attractiveness of different strategic options for your company
The graphic method of analysis (below) helps you in understanding the concept of the break-even point. However, the break-even point is found faster and more accurately with the following formula: Q = FC / (UP – VC)where:
Q = Break-even Point, i.e., Units of production (Q),
FC = Fixed Costs,
VC = Variable Costs per Unit
UP = Unit Price
Therefore, Break-Even Point Q = Fixed Cost / (Unit Price – Variable Unit Cost)
What Are Sales?
Sales refer to the amount of money a company receives from selling its products.
- Gross sales are the total money a company has received before any expenses (money spent on production) have been paid for
- Net sales are the total money a company has received after subtracting expenses.
The cookie company’s net sales include the money they’ve received from selling their cookies, but they have already subtracted what they spent on cookie ingredients, for example.
Fixed costs are the costs that stay the same no matter how many products a company makes. An example for the cookie company might be electricity or rent.
Variable costs are the costs that change depending on how many products a company makes. For example, if the cookie company decides to produce 100 cookies instead of 50, they will need more flour, sugar, butter, eggs, and chocolate.
To keep things simple, this cookie company’s fixed costs are only rent and electricity. Every month, they need to spend $500 dollars on rent, and $100 dollars on electricity. Their total fixed costs are $600 dollars.
And every month they buy large quantities of flour, sugar, butter, eggs, and chocolate, and they’ve calculated that they usually spend $2 on ingredients for every cookie they make.
BEP Example Calculation
For example, if a company has $10,000 in fixed costs per month, and their product has an average selling price (ASP) of $100, and the variable cost is $20 for each product, that comes out to a contribution margin per unit of $80.
Then, by dividing $10k in fixed costs by the $80 contribution margin, you’ll end up with 125 units as the break-even point. This means that if the company sells 125 units of its product, it’ll have made $0 in net profit.
Or, if using Excel, the break-even point can be calculated using the “Goal Seek” function.
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.