If you’re starting a small business or are currently running one, you should have one major thing in mind—at what point will your business become profitable? This can be solved by knowing how to calculate your break-even point.
To stay afloat, at some point businesses must be able to turn a profit. Along the way, there are many expenditures, including both fixed costs and variable costs. You’ll need to have a firm idea of how many products or services you must sell to offset these costs and become profitable.
A break-even analysis is a great tool that tells you at what point your total costs meet your total revenues. It can be used to test out business ideas, determine whether or not you should introduce a new product to your business, or show what will happen if you change your pricing strategy.
In this guide, we’ll tell you everything you need to know about the break-even point. We’ll go over why it’s important and the different formulas you can use for your company.
What is the break-even point?
The break-even point is when a company’s total costs meet its total revenues. Put simply, it’s the turning point for when a company is able to make a profit.
Businesses use a break-even analysis to figure out how many units or services they need to sell to become profitable. When total costs match total revenues during a period of time, the company hasn’t yet made a profit, but it also hasn’t lost money at this point.
Once a company surpasses this point, it has become profitable. Until then, a company is losing money.
So why is it important to calculate the break-even point for your business?
Why is the break-even analysis important?
The break-even analysis can help people who are thinking about pursuing a business venture or already operating a business. It helps you determine the feasibility of a business venture and ways you can improve your current practices.
Your business needs to make financial sense. If turning a profit seems almost impossible, then you may want to reconsider the idea or adjust your current business model to cut costs and bring in more revenue.
As the saying goes, it takes money to make money. Running a business requires you to spend money upfront on a range of fixed costs necessary for doing business. You also need to pay out money for every unit or service you produce.
Looking at all of these expenditures can be intimidating, but knowing the exact number of units you need to sell—or the precise amount of revenue required—to become profitable can ease your mind. That’s where the break-even analysis can bring clarity to the financial aspects of your business model.
Current business owners can use a break-even analysis to tinker with their pricing strategies or to determine whether or not to develop a new product or service. The break-even analysis can tell you if it makes financial sense to launch new products by showing how many units you’ll need to sell to break-even.
How to calculate break-even point
In order to calculate your break-even point, you need to understand several other business metrics and how they apply to your company. You’ll need to know the sales price per unit, fixed costs, variable costs, revenue and contribution margin calculations.
1. Sales price per unit
This is the price you plan on charging customers. It’s in your best interest to set a price that leaves large enough margins so you can quickly break even. However, you don’t want to scare customers away with a high price. An appropriate selling price falls right around the point where supply and demand meet.
You’ll need to have a general idea of what your selling price per unit will be. Without this, you won’t be able to calculate a break-even point.
If you already have a business up and running, then you already know what you’re currently selling products and services for. If you’re testing out a business idea, then look at how your competitors are pricing their products and services to gauge what your selling price should be. Don’t worry if you don’t have a unit selling price set in stone since the break-even analysis will help you with finding the right price.
2. Fixed costs
Fixed costs are required expenses that you’ll need to pay, regardless of your production volume or service output. Even if you sell zero products, you’ll still be responsible for paying for these expenses on a monthly basis.
3. Variable costs per unit
The other component of your total costs are your variable costs per unit. This metric measures what you pay for producing each unit or service. The more units or services you sell, the more money you’ll need to pay.
Variable costs can include the raw materials to manufacture a product, the hourly labor wages for providing a service, sales commissions and shipping charges to send units to customers.
For example, if you sell burgers at your restaurant, you’ll need to track how much you paid for the beef, bun and toppings. For every burger you sell, your total variable costs will rise.
Revenue is how much money you bring in for selling your products or services before subtracting total costs. Think of it as the money you have coming in the door.
You can use this simple revenue calculation below.
Revenue = Number of units sold * Sales price per unit
Your revenue is also used to calculate your business’s profit. Profit is simply your total revenues minus your total costs.
5. Contribution margin
A product’s contribution margin tells you how much each sold unit contributes to your overall revenue. Products with a high contribution margin have a positive impact on your company’s growth.
The contribution margin per unit can be calculated using the following formula.
Contribution margin per unit = Sales price per unit – Variable cost per unit
You should be aiming for a high contribution margin per unit. If you have a high positive contribution margin for a particular unit, this means it’s a major contributor to your profit margin.
If you have a low or negative contribution margin for a particular unit, this means the product isn’t helping push the needle for total revenues, or even worse, it’s losing your company money to produce it.
6. Contribution margin ratio
The contribution margin ratio is similar to the contribution margin. The difference is that the contribution margin ratio is expressed as a percentage of the sales price per unit rather than a dollar amount.
The contribution margin ratio can be calculated with the following formula.
Contribution margin ratio = Contribution margin per unit ÷ Sales price per unit
Knowing this ratio allows you to answer questions like “What percentage of this unit’s sales price goes directly towards a positive contribution to my revenue?”
Now let’s take a look at some break-even analysis formulas you can apply to your business.
Break-even analysis formulas
These break-even analysis formulas can help you determine if you should pursue a business idea or optimize your current business practices. You can use them to experiment with your pricing strategies and find opportunities to increase revenue and cut costs.
Break-even point in units = Fixed costs ÷ Contribution margin per unit
Your break-even point in units will tell you exactly how many units you need to sell to turn a profit. If you’re able to sell more units beyond this point, you’ll be making a profit. If you’re unable to sell enough products or services to meet this point, then your company will be losing money.
To calculate, you’ll take your fixed costs and divide them by your contribution margin per unit. Therefore you can also break this formula down even further and write it out as follows:
Break-even point in units = Fixed costs ÷ (Sales price per unit – Variable cost per unit)
Once you have your break-even point in units, you’ll be making a profit on every product you sell beyond this point. Your contribution margin will tell you how much profit you’ll make on each unit once you pass this break-even point.
But what if you want to know what your break-even point is in dollars?
Break-even point in dollars = Sales price per unit * Break-even point in units
Once you have your break-even point figured out, you can start experimenting with other formulas. This formula, in particular, will help you experiment with your unit selling price.
If you have your break-even point in units, you can multiply that by the sales price per unit. This gives you the dollar amount of your break-even point.
You can then experiment by plugging in different figures for your sales price or unit sales volume. You can use this break-even analysis calculator to quickly drop in metrics and see where you net out.
For example, you could increase your sales price, which would require you to sell fewer units to break even. You could also lower your price which would push your unit break-even point even higher.
Break-even point example
As a business owner or aspiring entrepreneur, you may be wondering how you can apply this to your current situation. To paint a clearer picture, let’s walk through a real-world example.
Let’s say you sell only gourmet burgers at your restaurant. You run a tight ship and are able to keep your costs fairly low. Here’s a peek at your financials.
- Fixed costs: $1,200
- Variable costs per unit: $4
- Sales price per unit: $12
Your fixed costs consist of your monthly rent, utilities, a point of sales system and any payments on your business loan. Your variable costs per unit are the beef, buns and toppings used to make your delicious gourmet burgers.
You can take these figures and plug them into the unit break-even point formula:
Break-even point in units = Fixed costs ÷ (Sales price per unit – Variable cost per unit)
Your formula will look like this:
150 burgers = $1,200 fixed costs ÷ ($12 per burger – $4 variable costs)
This means that you’ll need to sell 150 burgers over the course of the month to break even.
You can then start experimenting with your pricing and other aspects of your business strategy by inputting different figures to this formula.
How will you use the break-even analysis?
Now that you have a break-even analysis in hand, it’s time to start plugging in metrics to test your current business or startup idea.
If you’re thinking about starting a new business, do some quick projections and drop them into the break-even formula. The Small Business Administration has a great resource to help calculate startup costs you can use to support your projections and figure out if your idea is worth pursuing.
If you’re already running your own business, you can always optimize your pricing strategies or find ways to increase your profit margins. Using a break-even analysis is a great way to reach profitability and ensure you’re never leaving money on the table.