The Break-Even Point - What is it?

By: First Union


The Break-Even Point - What is it?

Breaking even is what many businesses strive for in the early phase of the company's life. The break-even is the point at which revenue finally equals cost. Understanding break-even and knowing how to calculate that break-even point enables you to better determine both fixed and variable costs and thus set your prices accordingly. In this article, we look at the concept of break-even and we also review how to determine that break-even point.

The break-even point

As noted, the break-even point is that point where revenue equals cost. Once you have come to the number representing this break-even point, you are going to need to seriously evaluate all relevant costs in conjunction with your pricing. That is to say, do your prices make sense in light of where your costs are currently at? You may decide your pricing structure isn't robust enough. By the same token, you might see that costs are much too high to reach that break-even point in a realistic amount of time.

When it comes to calculating your break-even point, there are a couple of ways you can go about this. You can either determine the break-even point based on units sold. Additionally, you can also calculate this number by factoring sales dollars into an equation.

When calculating the break-even point using units sold, you will divide all of your fixed costs by revenue per unit minus variable costs per unit. So your fixed cost is such that is always the same regardless of how much product you sell. Revenue means what you are selling the product for minus variable costs which include labor and materials among other things. The formula will therefore look like this:

Break-Even Point (Units/) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit/)

When using sales dollars to calculate your break-even, you will divide fixed costs by contribution margin. The contribution margin is arrived at by subtracting variable costs from product price; this then will go toward fixed costs. That formula consequently will look like this:

Break-Even Point (sales dollars/) = Fixed Costs ÷ Contribution Margin

Contribution Margin = Price of Product – Variable Costs

Looking closer at some of the elements involved with this break-even formula, it is important to note again that fixed costs remain unaffected by the product sold. These could include things like rent and utilities, also marketing expenses, and technology costs. The contribution margin represents the number you get upon subtracting variable costs from selling price. Let's say for example your item costs 150.00. The cost of materials was 25.00 and the labor price involved was 60.00 This means that your contribution margin here would be 65.00. The 65.00 then would be put toward fixed costs—if there is money left over, there is where your net profit comes in.

Upon getting to that point where your sales equal fixed and variable costs this is the break-even point. At this juncture, your profit would be zero. And then moving forward, the sales that you make beyond this break-even point go toward profit.

Understanding your break-even analysis

The break-even analysis and calculations enable you to figure out precisely where that break-even point is. That said, upon crunching the numbers, you need to make some determinations as far as pricing, costs, and market sustainability—that is to say, are your products going to do well in your given market? You might realize that given where the break-even point currently stands, you're going to have to sell much more than you anticipated and that could mean revisiting pricing and/or costs.

Arriving at your break-even point via a close analysis should tell you whether or not realistically you can meet your goals. And if not, potentially show you what may need some adjusting to hit that break-even number. And again, you want product evaluation to be a part of this as well. Even if the break-even point seems realistic, this doesn't automatically mean that your product will necessarily sell as it needs to.

Most small business owners will do a break-even analysis before launching their company. In this way, they are aware of the risks and consequently what they need to do to be successful. Additionally, for existing businesses, doing a break-even analysis before a new product launch is always a good idea, again to determine risk and whether or not the cost of the new product or line is going to be worth it once all is said and done. Here are a few of the ways that you can use your break-even analysis to advantage your business…

  • Revisit pricing. The analysis may reveal that the pricing is too low to get you to that break-even point within a comfortable timeframe. This should signal a pricing adjustment—just be sure it is comparable to competitor pricing.
  • Can you do better on materials? Perhaps your material costs are much higher than where you need them to be. Is it time to renegotiate with suppliers? Can you substitute materials without diminishing the quality?
  • Launching new products. As mentioned, existing businesses should conduct a break-even analysis to determine if a new product will be profitable.
  • Setting goals ahead of time. Knowing the numbers and how much you need to make to start being profitable can help you set more realistic goals. Let's say you want to undergo expansion in some form—the break-even analysis can show you exactly how much more productive you might need to sell to be able to start such a project.

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