A break-even point is an important financial component to any business which deals with a product or service. Understanding what it means, and how to calculate it helps you evaluate your business’ revenue model and how profitable it is. This blog will provide you with all the necessary information you should know about break-even points.
What is a break-even point?
The level of production at which the costs of production equals the revenues for a product. In other words, your sales equal your expenses. At this point there is no profit or loss because you ‘break-even’.
If you happen to fall below the break-even point, that means your business is making a loss. You should consider cutting down your expenses or increasing the cost. On the flip side, if you go beyond your break-even point, your business is making a profit as well covering operating costs. This is a very positive outcome! It may take a few years to reach profit territory, however calculating your break-even point will help you with pricing strategies and setting budgets.
How do you calculate a break-even point?
Like all most mathematical calculations, there is a formula to help you calculate your break-even point.
You will need the following data:
- Fixed costs – Expenses that remain the same, irrespective of the number of sales you make. This could be the running costs of your business, such as the rent you pay for your workspace/s and insurance policies.
- Variable costs – The expenses change based on your sales activity. For instance, if you sell more products, you may need to increase the direct materials required to manufacture more. You may also need to hire additional staff as your customer base increases if it is a service you are providing.
- Selling price of the product – How much you charge for one product/service.
Now that you have all the numbers you need, here’s the break-even formula:
Break-even Point Per Unit = Fixed Costs / (Sales Price Per Unit – Variable Costs Per Unit)
- Selling 5,000 units that costs £12 per unit would generate 5,000 x £12 = £60,000 in revenue.
- If the company sells 5,000 units, the company would incur 5,000 x £2 = £10,000 in variable costs and £50,000 in fixed costs for total costs of £60,000.
- The break even point is at 5,000 units.
The sales price per unit minus variable cost per unit is also called the contribution margin. Your contribution margin shows you how much take-home profit you make from a sale.
The break-even point is your total fixed costs divided by the difference between the unit price and variable costs per unit. Keep in mind that fixed costs are the overall costs, and the sales price and variable costs are just per unit.
How we can help
Here at Carrington Blake Accountancy we can help you calculate you break-even points as well other financial services to help your business thrive. Contact us today for further information on how our expert Accountants can make dealing with your finances easier.