Are you trying to figure out when you’ll make a profit? The breakeven point formula is an excellent way to calculate whether your business idea has the potential to create a net profit and, more importantly, how quickly.
We’ll help you understand the break-even point, what counts as fixed costs or variable costs, and how you can use financial modeling to improve your business strategy.
We’ll start by covering some of the managerial accounting terms a small business owner should understand to perform a break-even analysis. Next, we will show you how to calculate the break-even point. Finally, you’ll see how to estimate the number of units you need to sell to make a net profit that meets your goals.
Get ready to learn the different terms surrounding the break-even point equation.
To better understand how new or existing businesses can use the break-even analysis formula, you need to understand the following terms:
What is a Break-Even Point (BEP)?
The break-even point is the point in which revenue covers the cost of the fixed costs plus the variable costs. After reaching the break-even point, you are not losing money but making a profit.
You can measure the break-even point in either units or revenue. We’ll show you how to do both. First, let’s look at the rest of the definitions you’ll need to effectively calculate break-even point data.
What is the Sales Price?
The sales price is what you will be selling the product for. The sales price per unit, or unit-selling price, needs to be higher than the total expenses (variable costs plus the fixed costs).
While the price per unit variable is often defined by what market research shows as fair market value, you can use the break-even volume formula to determine the selling price to make the profit you want from a specific number of units. We’ll show you how to do that later.
Keep reading to better understand what a fixed cost is.
What are Total Fixed Costs?
Fixed costs are anything your business has to pay, regardless of how many products you sell and how much money you make. Fixed costs include:
- Monthly rent
- Property taxes
- Business licensing
- Electric bill (portion not impacted by production volume)
- Website and other software
- Executive salaries
- Benefits (if offered)
There are limitations to fixed costs. For instance, screen printing machines typically can’t produce more than 1,000 per hour. If you run it constantly (unlikely), that means a max of 24,000 shirts per day before you need more screen-printing machines (and probably more employees).
Some people might want to guide their pricing strategy based on how many units they need to sell to cover fixed costs. Dividing the total fixed costs by the number of units in inventory will help to establish the Unit Fixed Costs. If you need to do that to help you establish your price per unit variable, just use the following formula:
What are Variable Costs?
A variable cost is any cost that increases as you sell more products. Using the example of screen printing, some of the variable costs would include:
- Cost of the t-shirt or other items
- Costs of the screens and ink
- Labor to perform the t-shirt printing
- Product packaging
- Shipping charges
- Sales commissions
- Transaction fees
- Advertisement charged by Cost Per Action (CPA) ads
- Electricity that is directly attributable to the printing.
If you don’t know the variable cost per unit, you can divide total variable costs by the units sold to calculate the variable costs per unit using the formula:
Fixed and Variable Costs Equal Total Costs
Break-even analysis determines the intersection of total costs and revenue. The total cost of a business can be found with the formula:
Total Cost = Fixed Costs + Variable Cost
What is the Contribution Margin?
The contribution margin is used to establish how much of a product’s revenue contributes to reaching the break-even point. The contribution ratio is calculated based on the difference between the sales price and the variable costs.
You can also calculate the contribution margin as a ratio. To calculate the contribution margin ratio, you simply divide the contribution margin by the sales price, as you can see in the picture above.
What is the Break-Even Point Formula?
The break-even point formula can be used to calculate the number of sales needed or the revenue needed. We’ll look at both ways to calculate the break-even point below.
To calculate the break-even point in units, you will simply divide the fixed costs by the contribution margin. The equation can be written in two ways:
Example: How to Calculate Units Using the Break-Even Quantity Formula
Let’s pretend you are selling hoodies and use the following assumptions:
Note on SP and VC: The Sales Price was calculated using my Etsy Pricing Calculator and a two-sided Unisex Fleece Hoodie | Hanes P170 (Light Steel / 2XL) with front and back print from Printful for $29.40. The back print adds $5.95 to the price listed in the link.
Note that the break-even point is not an even number, so we have to round up to 656 hoodies sold to break even. That’s how to calculate the break-even point. At the break-even point, you’ll start earning $15.25 in profit per unit sold.
Keep reading, and we’ll input the information into the break-even revenue formula.
Example: How to Calculate Total Revenue to Break Even
From the previous example, we know
I created a break-even point calculator to help you calculate this really easily. Check out the break-even point calculator.
You can take this beyond the breakeven point and calculate how much revenue you need every month to earn a certain amount of revenue.
Example: Break-Even Analysis to Earn $200K a Year
Break-even point analysis can also be used to estimate how many units you need to sell to make a profit. Let’s continue with the previous example:
At this point, our break-even analysis has established that with a $69 sales price and $15.25 contribution margin, we will need 13,771 Units and $950,199 in revenue. This is helpful for business planning and establishing that you have enough inventory.
How to use the break-even formula with multiple products
As you research break-even analysis, you may find that it works best with a single product. Most companies sell more than one product, though. While this does not impact the fixed costs, it will impact the sales price, sales volume, and variable costs.
There are several ways to deal with these challenges, and we’ll discuss them below.
Adjusting Sales Price Based on Multiple Products
There are several ways to adjust the break-even analysis based on different sales prices. These are the two easiest ways:
The first equation is easiest to use if you have the actual sales dollars and the number of products sold, so they are easy to calculate. The second equation is more useful when you don’t have total revenues and specifically focus on forecasting.
For instance, with over 50 years in the clothing industry, The Adair Group estimates the distribution of hoodies bought as
- L: 30 percent
- M: 28 percent
- XL: 20 percent
- XXL: 12 percent
- S: 7 percent
- XXXL: 2 percent
- XS: 1 percent.
Those numbers make it so you can accurately estimate the sales price per unit for multiple products if you have a different selling price for each.
A business’s break-even point will be impacted by the variable costs, and when you are selling multiple products, you have a few ways of dealing with this:
In the table below, I used the hoodie front pricing to calculate it. Still, since the total percentage was only 99%, I divided the final weighted cost total by .99 to get $22.19, which raised the weighted cost by approximately 22 cents.
You can use the same formulas as above to calculate contribution margin or use this nifty hack I like to use.
- Only carry similarly priced products.
- Choose a contribution margin strategy based on a specific dollar or % profit.
- Choose the highest-cost product. In our example above, it was the 3XL at $24.95.
- Establish how much you want to make on it. I use $10 for hoodies.
- Using the Etsy Pricing Calculator provided earlier, $56.60 would be the sales price.
- Make all your products the same $56.60
- Now you have both sales dollars and contribution margins that are easy to calculate.
We’ll use the pricing that we discussed to do a break-even analysis using the following values:
Notice how 1,00 is a nice round number. When you calculate how much revenue you need to cover, fixed and variable costs are quite simple. The formula is the $56.60 Sales Price multiplied by the 1,000 units.
BEP ($) = SP*BEP (Units) = $56.60*1,000 = $56,600
This makes it where you have normalized your contribution margin, and it’s easy to figure out the break-even point. You can do the same thing with the contribution margin ratio if you’d prefer to do it that way.
Small businesses can use this knowledge in various ways, including:
We’ve looked at terms that describe what break-even analysis shows, shown how to calculate break-even point, provided you with a calculator that simplifies how to find break-even point, and reviewed examples to find the dollar amount and units you would need to sell to break even.
We hope this knowledge helps you make better pricing and forecasting decisions. Have you used the break-even formula before? If so, how did it impact your decision-making?