As a business owners, it is important that you understand exactly how your business is performing at any given point in time. There are a few different measures you will use for this, but many of them involve knowing your break-even point. For this information, you will need to understand how to calculate your break-even point. But how do you go about doing that?
In this article, we will explain exactly what a break-even point is, why it is important to be aware of and how you can calculate it. We will also discuss how you can improve the breakeven point of your business to maximise your profitability. After all, the goal of any business is to turnover a profit and ultimately be successful.
What is a break-even point?
A break-even point (BEP) is the point at which a business’ total costs equal its total revenue. This means that the business is neither making a profit nor experiencing a loss.
At the break-even point, a business is operating in exactly the same way as it would if it were not making a profit. The only difference is that it is breaking even, rather than losing money. If the business is operating above the break-even point, it will be profitable, whilst if it is operating below the break-even point it will be making a loss.
Why is a break-even point important?
The break-even point is an important metric for business owners to understand, as it shows when their business will start to make a profit. After reaching the break-even point, the business will be making a profit on each unit sold.
Knowing your break-even point is essential for making informed business decisions, such as pricing products and deciding on production levels. If the break-even point is too high, the business may not be able to cover its costs with sales and will need to find ways to reduce expenses or increase revenue. Conversely, if the break-even point is too low, the business may be leaving money on the table by not charging more for its products.
There are a number of factors that can affect a business’ break-even point, such as the cost of goods sold, overhead costs, and sales volume. It is important for business owners to track these numbers as closely as possible, as this will help them stay on top of their expenses and revenue.
Calculating your break-even point
In order to calculate your break-even point, you will first need to know the fixed and variable costs of the business. Fixed costs are those expenses that remain the same even when the company experiences a change in sales. These fixed costs are also known as overhead. Variable costs are expenses that increase or decrease depending on how many items the business sells.
There are two different ways of calculating your break-even point: either in units sold or sales revenue. Let’s take a look at the break-even formula for each of these measures.
Break-even formula – units sold
To calculate how many units you need to sell to break-even, you will first need to subtract the variable cost per unit from the sales price per unit. You will then divide the fixed costs of your business by this number.
So, here’s the formula for calculating your break-even point by units sold.
Break-even point (units) = fixed costs / (sales price per unit – variable cost per unit)
Break-even formula – sales revenue
If you would prefer to calculate your break-even point based on the sales revenue you will need to achieve in order to break-even, you will first need to calculate your contribution margin. This figure is calculated by subtracting your variable cost per unit from your sale price per unit, and then dividing that number by the sale price per unit.
Contribution margin = (sale price per unit – variable price per unit) / sale price per unit
Once you know your contribution margin figure, you can then calculate your break-even point based on your revenue. To do this, simply divide your fixed costs by your contribution margin.
Break-even point (revenue) = fixed costs / contribution margin
What is breakeven point example?
Let’s take a look at an example of calculating a break-even point, to further explain how to calculate the breakeven point of your business.
Imagine a company that sells bath bombs. The company has fixed costs of £9,000 per month, which includes its rent and staff wages. Each bath bomb costs £1 to produce and is sold for £4. The company wants to work out how many bath bombs it needs to sell each month in order to break-even.
So, we will take the sales price per unit of £4 and subtract the variable cost per unit of £1, leaving £3. We will then divide the fixed costs of the business (£9,000) by this number, which gives us 3,000. This means that the company needs to sell 3,000 bath bombs every month in order to break-even.
If the business sold more than 3,000 bath bombs in a month, it would be making a profit. On the contrary, if the business sold less than 3,000 bath bombs in a month, it would be operating at a loss.
When you don’t meet your break-even point
There are a few different ways that a business can reach its break-even point. It can either increase its sales volume, reduce its fixed costs, or reduce its variable costs. If a company is unable to reach its break-even point through any of these methods, then it will be operating at a loss.
In some cases, a business might choose to operate at a loss in order to gain market share or to increase its revenue in the long term. If the company is not able to reach this volume through regular sales, then it might lower its product prices below what it actually costs them to produce in order to attract more buyers. This would be a strategic decision made by the company’s management in order to stay afloat and improve its future prospects.
Does every business have the same break-even point?
While calculating a break-even point is a useful exercise for any business, it is important to note that not all businesses will have the same break-even point. For instance, a small business that operates out of a home might have a much lower break-even point than a large corporation. This is because the small business has much lower fixed costs, such as rent and employee salaries. Conversely, the large corporation will have higher fixed costs due to its size and the many departments that it must operate.
Is a high break-even point good?
If you have a high break-even point, this means that you will need to turnover more revenue before your business begins to make a profit. If your break-even point increases, there could be many reasons for this, including an increase in fixed costs, an increase in variable costs or a decrease in the sale price of your products or services.
If you’re hoping to achieve high profit margins, a low break-even point would be ideal for your business. This means that you won’t have to sell as many units before you begin making a profit, helping to boost the profit that your business is making.