Break Even Point is the number of sales a business needs to achieve where its revenue and costs are matched. This means there is no profit or loss to the business.
There are two ways to calculate break even point of a business. The first way uses sales units of the business and the other uses sales revenue.
Calculating Break Even Point (Units)
The formula for calculating Break Even Point in terms of units is:
Break Even Point= Fixed Costs / (Revenue per Unit – Variable Cost per Unit)
= F.C./(R/Unit – V.C./Unit)
This formula produces the result for how many units a business needs to sell to achieve Break Even. This means producing this amount of units will achieve $0 Profit and $0 Loss. Any more sales will lead to a Profit. Any less will lead to a Loss.
Calculating Break Even Point (Sales Revenue)
To calculate the Break Even Point of a business in terms of Sales Revenue, the following formula is used:
Break Even Point (Revenue)= Fixed Costs / Contribution Margin
To make use of this formula, you will also need to calculate the Contribution Margin of the business. The formula for that is:
Contribution Margin= Sales Price per Unit – Variable Cost per Unit
Alternatively, you can merge these formulas and calculate Break Even in terms of Revenue through the following formula:
Break Even Point (Revenue)= Fixed Costs / (Sales Price p.u. – Variable Cost p.u.)
This formula produces the result of how much Sales Revenue a business needs to break even.
Key: Breakdown of Terms in Break Even Formulas
Fixed Cost: The Fixed Cost of the business are the expenses the business needs to pay out that are not dependent on production units. This is calculated by summing up all fixed costs. A good example of this is Rent.
Revenue Per Unit: This is the Sales Price of a unit.
Variable Cost Per Unit: This is calculated by Total Variable Costs / Sales Production Units. The Variable Cost Per Unit shows the amount of expense risen due to the production of a single unit.
Variable Costs: These are the total expenses to the business that are directly dependent upon the production of units.
Contribution Margin: The contribution margin shows the revenue amount in a unit’s selling price that covers the total fixed cost incurred by the business. For example, a product that sells for $50 and has $30 Variable costs will have a contribution margin of $20 dollars. If the total fixed cost is $200, 10 sales of these units will cover the fixed cost ($200/$20= 10).
Why Businesses Calculate The Break Even Point?
Break even point is one of the most important figures for a business. The reason for calculating this is for the management to understand at what amount of sales generated by the business will the business meets its costs.
This is especially important for new businesses. As new businesses are mostly covered by many expenses and to penetrate in a market they need to compromise on their costs, they mostly see themselves facing losses.
This is why these businesses have their primary goal of achieving Break Even. This means for businesses starting up, their first goal is to achieve a point of sales where they don’t face any losses.
For already existing businesses that have a firm step in the market, the importance of Break Even Point is still very high.
Even though these businesses have the primary goal for profits, and are very likely to be achieving profits, they still need to know the number of units they need to sell at least to not face a loss. This is a benchmark for the business, even when the actual amount of sales are very much higher than it.
The second main reason why businesses use Break Even Point is for decision making. Knowing the break even point of the business helps the business make price related decisions.
Businesses change their prices with time. No matter how profitable their products are, to keep track with inflation and changes in the business environment price changes are inevitable. When changing prices, a Break Even analysis will help the business know how many products a business would need to sell at the proposed prices. Whichever price helps the business achieve the break even point easily, practically, will be a good option.
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