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Knowing your break even point gives an entrepreneur a financial polestar. Every decision you make, before you boost profitability, should be geared toward hitting your break even point.
Read on to learn what the break-even point is, how to calculate it, and how it can help you master your business and increase sales.
What Is Break-Even Point?
Break-even Point (BPE) in accounting, economics, finance, and real estate is the point at which total cost and total revenue are equal. In other words, you “break even”, which means that there is no net loss or gain. All costs that must be paid have been paid, and there is neither a profit earned nor a loss incurred.
A Break-even Point is used in a wide variety of situations. If you’re a new business, people who are interested in investing in your business will want to know their return and when they will receive it. Some new businesses will struggle during the first year and may take several years to earn a profit. Existing businesses can use Break-even Points to analyze costs, including operating costs, and profits, in addition to showing the ability to rebound from difficult circumstances.
In accounting, Break-even Point refers to a situation where a company's revenues and expenses were equal within a specific accounting period. In real estate, a property's Break-even Point would show how much money the owner would need from a sale to precisely offset the net purchase price (including closing costs, fees, insurance, interest, and taxes) in addition to the costs connected to home maintenance and improvements.
The stock market is another industry in which Break-even Point can be frequently seen. The Break-even Point (or Price) for a trade or investment is determined by comparing the market price of an asset to the original cost. The break even cost is reached when the two prices are equal.
How to Find Break-Even Point
The information required to calculate a business's Break-even Point can be found in its financial statements. The first pieces of information needed are the fixed costs and the gross margin percentage. A company must maximize revenue to cover its fixed and variable costs. More sales mean there will be a profit, while fewer sales mean there will be a loss.
The accounting Break-even Point is calculated by taking the total expenses on a particular production and calculating how many units of the product must be sold to cover the expenses paid. In real estate, you need to know three key pieces of information- the debt service of the property (payments that are geared towards reimbursing the interest and principal on a loan), the operating expenses of a property (accounting, insurance, maintenance, repairs, taxes, and utilities), and the gross operating income of the property (the gross potential income minus the vacancy loss and credit loss).
Regarding the stock market, you could make money using stock options. Depending on the option you buy, it’s possible to make money when the price goes up or down. Before you can start figuring the Break-even Point, you must calculate how much the option cost to purchase. Then, figure the per-share cost by dividing the total cost by the number of shares you have the option to buy or sell.
Break-Even Point Formula
The break-even formula can be utilized in two ways, depending on whether you’re working with units or dollars. The first is by determining the number of units that need to be sold, and the second is the number of sales, in dollars, that need to happen.
To calculate in units, use this break-even formula:
Break-even Point in units= fixed costs / (sales price per unit - variable costs per unit)
Fixed costs are the ones that typically don't change or only vary slightly. Examples of fixed costs for a business are monthly rent and utility expenses. Sales price per unit is how much a company is going to charge consumers for just one of the products that the calculation is being done for. Variable costs are costs directly tied to the production of a product, such as materials used, or labor hired to make the product. It’s necessary to have this information to use in your break-even formula.
To determine variable costs per unit, this is the calculation you use:
Variable costs per unit= Total variable costs/ total units produced
To calculate in dollars, use this break-even formula:
Break-even Point in dollars= fixed costs / contribution margin
As previously mentioned, fixed costs usually don’t change, or only fluctuate a bit. Contribution margin is the difference between the price of a product and what it costs to make that product. This is another vital piece of information to include in your break-even formula.
To determine the contribution margin, use this calculation:
Contribution margin= (sale price per unit - variable cost per unit) / sale price per unit
Break-Even Point Calculator
Here is an example of the break-even calculator using units:
Steve’s is a soft drink manufacturer in the Buffalo area. He is considering introducing a new soft drink called Steve’s Root Beer, but he wants to know what kind of impact this new drink will have on the company’s finances. He decides to use the break-even calculator so that he and his management team can determine whether this new product will be worth the investment.
For the first month, the product will be in production, his accounting costs are as follows:
Fixed Costs = $2,000 (total, for the month)
Variable Costs = .40 (per can produced)
Sales Price = $1.50 (a can)
Fixed costs / (sales price per unit – variable costs per unit)
$2000/ ($1.50 – $.40)
Or $2000/1.10 =1818 units
This means that Steve needs to sell just over 1800 cans of the new soda in a month to reach the Break-even Point. The break-even calculator has provided him with this important figure so that he’ll know exactly how many sales he needs to make.
Now, let's look at the break-even calculator in dollars for Steve’s new soft drink:
Fixed costs/contribution margin (sales price per unit – variable costs per unit, with resulting figure then divided by sales price per unit)
$2000/.7333 = $2727
This means that Steve’s team needs to sell $2727 worth of Steve’s Root Beer in that month to break even. Anything surpassing that amount will be a profit for the company.
To confirm this figure: you can take the 1818 units from the first calculation, and multiply that by the $1.50 sales price, to get the $2727 amount.
This amount is the same as the unit contribution margin result for this example. (The definition of contribution margin is essentially the same as the “margin Again, a very valuable dollar amount from the break-even calculator will help Steve plan his sales goals in dollars. Using a break even calculator can help with time management tasks as it's one of the quickest ways to do the calculations.
Break-Even Analysis
Break-even Analysis tells you how many units of a product must be sold to cover the fixed and variable costs of production. The Break-even Point is a margin of safety for a business, as it shows how many sales it takes to pay for the expenses of doing business.
It can be very useful when determining the level of production or a targeted desired sales mix. It’s only appropriate for a company’s internal management team, as the data and calculations won’t be used by external groups such as investors, financial groups, and regulators.
There are several great benefits to using a Break-even Analysis. Firstly, finding your Break-even Point will help you determine the best prices for your products, and you will know exactly how much you need to sell to be profitable. Secondly, a Break-even Analysis helps a business to make smarter, more informed decisions based on facts instead of emotions. It helps new businesses avoid overlooking expenses when you're starting the company and limits any unpleasant surprises in the future. You will be aware of all financial commitments early in the process.
Furthermore, a Break-even Analysis can mitigate risk by showing when to completely avoid a business idea. Through realistic analysis of potential outcomes, it helps potential new businesses steer clear of failure and minimizes the financial damage of a bad business idea.
Finally, a Break-even Analysis will prove that idea or plan is viable and provide reassurance to you and your investors when committing to financial investment.
What Is the Break-Even Analysis Formula?
The break-even analysis formula is as follows:
Break-Even Quantity = fixed costs / (sales price per unit -variable cost per unit)
Now let's use the Break-even Analysis formula in an example:
Kristine is the managerial accountant in charge of Aqua Fitness, which sells water bottles. She previously determined that the fixed costs of Aqua Fitness consist of a lease, property taxes, and executive salaries, which total $100,000. The variable cost associated with producing one water bottle is $2 per unit. Aqua Fitness sells its water bottles at a premium price of $12. To determine the Break-even Point of Aqua Fitness's premium water bottle, we use the Break-even Analysis formula:
Break-Even quantity = $100,000 / ($12-$2) = 10,000
Therefore, given the fixed costs, variable costs, and selling price of the water bottles, Aqua Fitness needs to sell 10,000 water bottles to "break even.”
The knowledge of calculating Break-even Points can help you avoid starting a business that’s doomed to fail, not accepting enough money for your property to help offset other financial costs, and launching a new idea in your business that won’t show a return on your investment. There are many eCommerce ideas out there and breaking even is a crucial step of the business process. It's one of the eCommerce metrics you need to know.