As a small business owner or if you are involved in business accounting, you may have come across the concept of the break-even point. This calculation can be important as it helps your business to manage its costs better and improve your financial future. This is why we've compiled this short guide to what the break-even point is, the formula, how to calculate it, and usage examples.
Break-Even Point Definition in Business
The break-even point refers to the amount of revenue required to cover a business's fixed costs/expenses and variable costs/expenses. The break-even point, i.e. income generated to cover all expenses in a certain period, can be measured in monetary value or hours worked by a company's staff. Break-even points are used in different areas of business.
Identifying your company's break-even point is important as it helps you understand whether you need to, for example, increase your prices or cut down on expenses by working on lowering your company's total fixed and variable costs to break even or, even better, make a profit. Calculating your business's break-even point can help set prices and develop budgets.
What is the Break-Even Point Formula?
Generally, there are two methods of calculation, depending on business requirements:
- Based on units: The formula for this method is as follows: Break-even Point (Units) = Fixed Costs / (Revenue Per Unit – Variable Cost Per Unit).
- Based on sales: Break-even Point (Monetary Amount) = Fixed Costs + (Cost per Unit x BEP in Units). You need your company's BEP in units to use this method.
How to Calculate Break Even Point Formula?
Key variables in the formula for BEP include:
- Fixed costs: Fixed costs refer to expenses independent of the number of sales (e.g., rent, salaries).
- Variable costs: Variable costs refer to any cost that depends on the number of products or services sold by your company (e.g., materials for production).
- Contribution margins: Contribution margins refer to the selling price per unit, minus the variable cost per unit.
- Sales price: Sales price refers to how much your company charges for a product or unit.
Example of using the Break-Even Point Formula
Example 1: Company A spends GPB 200,000 on manufacturing costs. The costs for factory labor and raw materials vary, depending on the number of products sold by Company A. These variable costs add up to EUR 0.95 per unit. Each unit is sold at GPB 2.50.
- To calculate the break-even point in units, the formula would look as follows: 200,000 / (2.5 – 0.95) = 129,032 units.
- To calculate the break-even point in monetary value, the formula would look as follows: 200,000 + (0.95 x 129,032) = c. GPB 322,580.
To break even, company A would have to produce 129,032 units and generate GPB 322,580 in revenue.
Company B (with fixed costs of GPB 550,000 and product price of GPB 100) wants to reduce its variable costs by GPB 20, from GPB 60 to GPB 40. This means it takes fewer units sold to break even:
- BEFORE: Break-even Point (Units) = 550,000 / (100 – 60) = 13,750 units.
- AFTER: 550,000 / (100 – 40) = 9,1667
Calculating the break-even point has different functions in different areas of business. While, in accounting, it is used to determine the amount of production at which the costs of production equal the revenues for a product, in investment, the break-even point is reached once the market price of an asset equals its original cost.
- Why is break-even important?
Your break-even point provides you with important benchmarks in future planning. The break-even point refers to the amount of revenue required to cover a business's fixed costs and variable costs which means it helps you develop e.g. a pricing strategy.
- Is a higher break-even point better?
A lower break-even point means that your company has to sell fewer units or products to break even. A higher break-even point means your business has to sell more units or products to break even.