There are two formulas to calculate the break-even point: one for per unit sold and one for sales revenues.
In the first formula, you divide the total fixed costs by the difference between the unit price and variable costs. The formula looks like this:
Break-even point in units = fixed costs / (price - variable costs)
In the second formula, you divide the total fixed costs by the contribution margin (the sales revenue minus the variable costs).
Break-even point in sales = fixed costs / contribution margin
This formula is used by business owners to determine when their business will become profitable. You could also use it to determine whether you need to consider cutting costs or looking for alternative means of generating revenue.
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How to use the break-even formula for sales
Implementing the break-even formula for sales is simple with some practice. Follow these steps to find your break-even point in sales:
1. Calculate your company's fixed costs
Your company's fixed costs include things such as utilities, rent, insurance, property taxes and loan payments. Fixed costs include any of your company's expenses that aren't impacted by the cost of providing your service.
2. Determine variable costs
These are company expenses that fluctuate with sales. Examples of variable costs include materials and freight, and commissions paid to salespeople. If you have a car wash, an example of a variable cost could be the materials and soap you use to wash the cars. The more cars you wash, the more your variable costs will increase.
3. Determine product price
Determining the sale price of a service is important as you need the price to be at least as high as your cost of providing the service. When you're starting a new business or launching a new product you may choose to price your service lower to attract new customers.
4. Determine the contribution margin
The contribution margin is calculated by subtracting variable costs from the sale price. The contribution model represents the amount of money generated after recovering variable costs.
5. Calculate the break-even point for sales
Divide the fixed costs by the contribution margin. Again, the formula looks like this:
Break-even point = fixed costs / contribution margin
How to use the break-even point for units
This is accomplished in the same way as the break-even point for sales, only you substitute units for sales.
Calculate your company's fixed costs
Determine variable costs
Determine product price
Calculate break-even point for units
Break-even point in units = fixed costs / (price - variable costs)
How to interpret break-even formula results
Understanding a break-even point can help you make better, more informed business decisions. It can tell you whether you need to cut costs, raise prices or simply determine the number of products you need to sell to break even. Here are some ways you can interpret the data and use it in your daily operations:
Setting prices: You can use the data to determine if your pricing is too low or whether you should raise pricing to break even faster.
Tracking costs: By identifying your break-even point, you can also keep track of your business costs. You may find that you are paying too much for materials and thus reducing your profit. And the break-even point can also steer you towards ways to cut costs, such as reducing overhead or changing vendors.
Launching new products: Before you launch a new product, understanding the break-even point can help you make decisions about promotional spending, or whether a product is even something worth pursuing if the break-even point is too hard to achieve.
Setting goals: Knowing your break-even point is useful in setting realistic long- and short-term goals. Having an accurate picture of your company’s potential can help you stay on budget and on deadline.
Motivating employees: You can use the break-even point as a tool to motivate your team. Having clear goals and knowing exactly what is expected of them can make employees feel like valued members of the company.
Step-by-step explanation:
