The break-even point is a critical number that must be analyzed within a business. It’s the point where sales and expenses are the same, meaning sales are enough to cover expenses.
Although being at the break-even point does not allow for an income for the business, it does mean the company is able to pay all its expenses without going into debt or having to close its doors. Revenue beyond the break-even point contributes to net profit.
By calculating the break-even point, businesses can set prices appropriately and in turn, better predict when they will become profitable.
To calculate the break-even point, you need a few specific numbers
1. Selling price of the product
2. Costs – variable and fixed
a. Variable costs: Costs that are inconsistent and change based on production output or a change in sales volume. Wages, utilities, commissions and materials are examples.
b. Fixed costs: Expenses that remain relatively the same and don’t change based on production or sales volume. Capital expenditures, rent or mortgage, equipment expenses, taxes and insurance are examples.
3. Contribution margin – The excess between the product’s selling price and total variable costs.
formula: Contribution margin = Selling price – Variable costs
4. Contribution margin ratio – The percentage of a unit’s selling price that exceeds total unit variable costs.
formula: Contribution margin ratio = (Sales – Variable expenses) ÷ Sales
Formulas for the break-even point
There are two formulas for the break-even point. Choose based on whether you want to calculate your break-even point in units or in sales dollars.
Calculating the break-even point in units:
| Break-even point = (units) | Fixed costs | ÷ | Contribution margin (selling price – variable costs) |
Calculating the break-even point in sales dollars:
| Break-even point = (sales dollars) |
Fixed costs | ÷ | Contribution margin ratio (contribution margin per unit ÷ selling price) |
To get a better understanding of the above formulas, let’s work through some examples.
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Finding the break-even point in units
Company A sells its products for $40 per unit. Annual fixed costs are $100,000. Variable costs associated with manufacturing the product are $20 per unit.
A’s contribution margin (selling price – variable costs or $40 – $20) is $20.
| Break-even point (units) = | Fixed costs | ÷ | Contribution margin |
| 5,000 = | $100,000 | ÷ | $20 |
Company A’s break-even point, where it will report a net profit or loss of $0, is 5,000 units.
Finding the break-even point in dollars
To find Company A’s break-even point in dollars, first find the contribution margin ratio.
A’s contribution margin ratio (contribution margin per unit ÷ selling price or $20÷$40) is .50.
| Break-even point (sales dollars) = | Fixed costs | ÷ | Contribution margin ratio |
| $200,000 | $100,000 | ÷ | 0.50 |
Company A’s break-even point in sales dollars is $200,000. All incremental sales beyond this point would contribute toward the accumulation of profit.
What the break-even point tells you
After calculating your break-even point, you may realize you need to sell a lot more products than you thought just to break even.
You may be able to change a couple of these variables. Perhaps you can raise prices or reduce costs, or both. If the plant is too big, you might downsize and still produce efficiently. Maybe you can find less pricey materials and better production methods to save on labor.
But you should also consider whether your products or services will succeed. Just because the break-even analysis tells you the number of products you need to sell, there’s no guarantee that they will actually sell. And even if you can change all three variables — fixed costs, variable costs and price — you may not be able to change them enough.
Ideally, the break-even point is calculated before starting a business so you can assess the risks and decide whether it’s worth it.
Other applications of the break-even point
Beyond business forecasting, the break-even point can also be useful for some daily operations. For example, the break-even point can help with:
Allocating capital: Understanding the level of output for your business’s revenue to be equal to its total costs can help you better allocate capital.
Assessing costs: Knowing the break-even point can help you decide whether costs, such as for materials and labor, are sustainable. If not, you’ll need to find a way to maintain the desired level of quality while lowering costs.
Pricing: If the break-even analysis shows your current price is too low, you can then consider increasing it. Just be sure to check the price for comparable items so you don’t price yourself out of the market.
Product launches: Estimating the break-even point for an individual product could help you assess whether it’s a viable addition to your lineup.
Setting goals: Knowing the precise number of units you must sell or amount of money you must make to break even will help you set more concrete sales goals. Identifying a target number can also motivate employees.
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