“When will my business start making a profit? That’s a big question for anyone starting a business. That’s why doing a break-even analysis is so important. It helps you figure out the fixed costs, like rent, and variable costs, like materials, so you can set prices right and predict when your business will start making money. At the heart of this analysis is finding the break-even point, the moment when your business covers all its costs and begins to make a profit.”
Table of Contents
What Is the Break-Even Point?
The break-even point is the moment in business when total revenue equals total costs, resulting in neither profit nor loss. At this point, a business covers all its expenses, both fixed (like rent or salaries) and variable (like materials or production costs). Beyond the break-even point, the business starts making a profit, while before it, there’s a net loss. Identifying the break-even point is crucial for businesses as it helps set pricing strategies, make informed financial decisions, and determine when profitability begins.
Break-Even Point Formula
The break-even point (BEP) can be calculated using the following formula:
\[ \text{Break-Even Point (in units)} = \frac{\text{Fixed Costs}}{\text{Selling Price per Unit} – \text{Variable Cost per Unit}} \]
This formula gives you the number of units you need to sell to cover all your costs and reach the break-even point. Here’s a breakdown of the components:
- Fixed Costs: The total of all fixed costs incurred by the business, such as rent, salaries, utilities, etc.
- Selling Price per Unit: The price at which you sell each unit of your product or service.
- Variable Cost per Unit: The cost associated with producing each unit, including materials, labor, and other variable expenses.
How to Calculate Break Even Point in Units
Calculating the break-even point in units involves a straightforward formula. Follow these steps:
1. Identify Fixed Costs:
Determine all fixed costs your business incurs, such as rent, salaries, utilities, etc. These are costs that do not change with the level of production.
2. Determine Selling Price per Unit:
Decide on the selling price for each unit of your product or service.
3. Find Variable Cost per Unit:
Identify the variable cost associated with producing each unit. This includes costs like materials, labor, and other variable expenses.
4. Apply the Break-Even Formula:
-
- Use the following formula to calculate the break-even point in units:\[ \text{Break-Even Point (in units)} = \frac{\text{Fixed Costs}}{\text{Selling Price per Unit} – \text{Variable Cost per Unit}} \]
- This formula represents the number of units you need to sell to cover all your costs and reach the break-even point.
5. Perform the Calculation:
Plug in the values from steps 1 to 3 into the formula and calculate the break-even point in units.
Break-Even Point Examples
Example 1:
Let’s say the fixed costs are \($10,000\), the selling price per unit is \( $50\), and the variable cost per unit is \($30\). Calculatedthe break-even point in units.
Using the following formula to calculate the break-even point in units:\[ \text{Break-Even Point (in units)} = \frac{\text{Fixed Costs}}{\text{Selling Price per Unit} – \text{Variable Cost per Unit}} \]
\[ \text{Break-Even Point (in units)} = \frac{10,000}{50 – 30} = \frac{10,000}{20} = 500 \text{ units} \]
Example 2:
If the fixed costs are \($15,000\), the selling price per unit is \($80\), and the variable cost per unit is \($40\), the break-even point in units is calculated as:
\[ \text{Break-Even Point (in units)} = \frac{15,000}{80 – 40} = \frac{15,000}{40} = 375 \text{ units} \]
Calculating the Break-Even Point in Sales Dollars
Calculating the break-even point in sales dollars involves determining the level of sales revenue needed to cover both fixed and variable costs. The formula for calculating the break-even point in sales dollars is:
\[
\text{Break-Even Point (in Sales Dollars)} = \frac{\text{Fixed Costs}}{\text{Contribution Margin Ratio}}
\]
The Contribution Margin Ratio is calculated using the formula:
\[
\text{Contribution Margin Ratio} = \frac{\text{Selling Price per Unit} – \text{Variable Cost per Unit}}{\text{Selling Price per Unit}}
\]
Example:
Suppose a business has fixed costs of $20,000, a selling price per unit of $100, and variable costs per unit amounting to $60. We can calculate the contribution margin ratio and then use it to find the break-even point in sales dollars.
Calculating Contribution Margin Ratio:
\[
\text{Contribution Margin Ratio} = \frac{100 – 60}{100} = \frac{40}{100} = 0.4
\]
Now, we can use this ratio in the break-even point formula:
Calculating Break-Even Point in Sales Dollars:
\[
\text{Break-Even Point (in Sales Dollars)} = \frac{20,000}{0.4} = 50,000
\]
In this example, the business needs to generate \($50,000\) in sales revenue to cover both fixed and variable costs and reach the break-even point.
