When your business ‘breaks even’, it means it has finally got to the point where the expenditure on manufacture = the revenue (these both are equal), and it’s no longer operating at a loss.
The break-even point is based on a simple equation. It’s equal to your fixed costs (e.g. rent, property taxes, equipment costs, and interest), divided by your average selling price, minus variable costs.
These are outgoings such as utilities, commissions paid to salespeople, and shipping costs. This calculation shows you the point at which your revenue is equal to your costs, and that’s the break-even point.
Anything above this represents your profits and means that your business is profitable.
What is break-even analysis and its purpose?
A break-even analysis can provide essential information about the financial viability of your company. This is particularly important when you’re putting together financial projections or when you’re expanding your product lines.
It can tell you whether you’ll need further investment to keep your business going until you reach the point at which you’re making a profit.
TheBreak-even point = Fixed costs / Contribution margin, i.e. the minimum turnover that must be achieved to not lose money. This will help you find out when your business will be profitable.
Break-even analysis
As the break-even analysis finds the moment of revenue versus expenditure balance, it’s an essential tool to manage your business’ finances and to strategise for making a profit.
In general, the lower your fixed costs, the lower your point for breaking even.
The sooner you can get to this point, the sooner you’ll be able to stop relying on external funding such as investment from your bank or other financial supporters.
This can save on interest payments and other funding costs.
It also means that if you need to look for a more investment to fund expansion or other growth plans, you’ll be able to demonstrate your track record on profitability, making you a more attractive proposition for lenders.
Break-even analysis purpose
A break-even analysis is an essential part of your business plan and your financial forecasts.
It’s a financial calculation that takes the costs involved in a new business, service or product and compares them with the unit selling price to identify the point at which you will find your business breaking even.
This is the moment at which you’ll have sold enough units or services to cover all of your costs. In other words, the good news is that you’ll have proven you have a profitable business.
What is the break-even formula?
It is relatively simple, you can break down the formula further as:
Break-even point = fixed cost/(average selling price – variable costs).
This formula takes into account both fixed and variable costs relative to the price that you charge per product—or the service delivered and—the profit.
How do you calculate the break-even point?
There are a number of online calculators that you can use to calculate the break-even point.
How to calculate the break-even point in units
First, you’ll need to make sure that you know all of the various costs of doing business. Checking through your outgoings will help here.
You’ll then need to separate your costs into your fixed costs and your variable costs.
Next, you need to consider your price. If you haven’t already decided on it yet, here’s your opportunity to find one that will deliver the profitability point at the right time for you and for your investors or lenders—as well as your customers, of course.
If you have a published price, and perhaps you’ve already been in business for some time, you can decide whether to stick to this price or adjust it.
If you’re planning to increase what you charge for your products, be prepared for an adverse reaction from customers and even the loss of sales in these challenging economic circumstances.
You also need to bear in mind any discounts you offer. From this you can calculate the number of units you need to sell in order to stop losing money.
This tells you when you have broken even in terms of units.
How to calculate the break-even point in GBP
To calculate your break-even point in GBP, you need to divide your total fixed costs by what is known as the contribution margin ratio.
The contribution margin is the difference between the price at which you sell your product and your total variable costs.
Just imagine that one of your products has a price of £100, your total fixed costs are £25 per unit, and your total variable costs are £60 per unit.
The next section has more detailed examples of break-even point calculations.
Break-even point: Examples
In our first example, the contribution margin of your product is £40, in other words, £100 minus £60.
The £40 contribution margin covers your remaining fixed costs, since these fixed costs aren’t included when calculating this contribution margin.
Taking the £40 contribution margin per item and dividing it by the £100 sales price gives you your ‘margin ratio’ of 40%.
So, if you imagine that the value of your entire fixed costs is £20,000 and you have a contribution margin of £40, you divide the £20,000 by £40.
This means that once you’ve sold 500 units, you’ve paid all of your fixed costs, and you will have broken even in pounds.
For our second example, imagine your company makes hairbrushes. Your fixed costs add up to £100,000. The variable cost associated with producing 1 hairbrush is £2 and you sell the hairbrush at £12.
To calculate when you’re at the point at which you’ll stop losing money, start by taking the sales price of 1 brush (£12) minus the variable costs to produce it (£2), which works out at £10.
Then take your £100,000 in fixed costs and divide it by the £10 (average selling price – variable costs).
This means you’ll have to sell 10,000 hairbrushes to reach profitability.
Break-even point FAQs
What is variable cost?
Variable costs are the costs a company incurs proportionately to production quantity or revenue.
These vary according to the cost of production such as manufacturing services, utilities, and labour.
Variable cost is used as part of the formula to calculate your break-even point and discover if your business is profitable.
What is the variable cost per unit formula?
The formula that shows you how to calculate variable cost is:
Total Variable Cost (TVC) = Total Units of Output x Variable Cost Per Unit of Output
How to find total variable cost?
To calculate variable cost, add together all fluctuating expenses outlined above within a specified period of time using the formula.
What is a variable costing income statement?
This is a financial statement prepared to contribute to the break-even calculation formula. You remove the variable expenses from the revenue calculation to make up the contribution margin.
Then, all fixed costs are subtracted from this to calculate the net profit or loss in that period.
You can then calculate the break-even point using the statements from fixed costs and variable costs.
