Why Calculate your Break Even point? .....#45
- Adrian Dionisio - business737 owner
- Dec 9, 2021
- 3 min read
Updated: Mar 26, 2024
Break Even Point
The Break Even Point (BEP) is where your business starts to make a profit. It is important to calculate and pay attention to this figure. Your BEP will help you decide prices, make decisions, design plans and set budgets.
BEP is the moment where revenue equals costs
Break-even analysis helps you to understand the financial health of your business. Importantly this figure will tell you exactly how many times you need to sell a product to offset the running costs of your business.
With BEP analysis you can take control of the elements that hinder you to break-even and also find ways to increase your profit margins.
The three main benefits of calculating the break-even point are:
It allows you to identify the right pricing strategy for your products;
It’s a reliable method to determine your profitability levels.
It enables you to discover hidden costs
How to calculate your Break Even Point
There are two main ways to calculate break even point
Method 1 – BEP based on Units (Volume)
BEP = Fixed Costs ÷ (Revenue Per Unit – Variable Costs Per Unit)
Imagine the average price of a product is $200. The monthly fixed costs are $2,000 and the variable costs are $100 per unit.
Using the above formula, you need to sell 20 units per month to break-even:
$2,000 ÷ ($200 – $100) = 20 units
Method 2 – BEP based on Sales ($)
Divide your fixed costs by your contribution margin.
The contribution margin is calculated by subtracting the variable costs from your average selling price.
BEP (Sales in $) = Fixed Costs ÷ (Revenue – Variable Costs)
Imagine your fixed costs are $150,000 each month. The contribution margin is 15%. The business reaches its break-even sales level at a sales threshold of $1,000,000 per month. $150,000 ÷ 15% = $1,000,000
Important!
Break-even analysis will establish the point at which your business starts to become profitable.
Before the break even point, a business is generating theoretical "profits" that correspond to the NET Profit Ratio.
After the break even point has been reached, the business is generating profits that correspond to the GROSS Profit Ratio.
Please over stand this point. After the break even point, all the fixed costs have been covered. You are now only covering the cost of good sold (variable costs).
After the BEP every transaction and sale becomes much MORE profitable. That is why profits will skyrocket after the breakeven point has been met.
Do you now understand why you MUST be aware of your break even point. This is a target that must be reached, no matter what!
Why is Break Even Analysis useful?
Break-even analysis allows you to project when and how you’ll reach break-even point. It helps you assess the sustainability of the business. It is also useful for investors to determine the point at which they'll recoup their investment and start making money.
The are two main ways to lower your break even point.
Increase Price (read more here)
Decrease expenses (read more here)
Break even analysis is also useful in the daily activities and planning of a business. Research how you can maintain a high level of quality whilst lowering your costs. Before you launch a new product, take into account both the new variable costs as well as the fixed costs.
When you know exactly how much you need to make, it’s easier to set longer-term goals. For example, if you want to expand your business and move into a larger space with higher rent, you can determine how much more you need to sell to cover new fixed costs.
If you know how many units you need to sell or how much money you need to make to break even, it can serve as a powerful motivational tool for you and your team.
Something to keep in mind
It is important to keep in mind that BEP analysis can be slightly inaccurate or misleading. For example,
Products are usually sold at different prices at different levels of output.
Fixed costs usually vary when output changes.
Sales are unlikely to be the same as output – there are returns, faulty items, build up of stocks or wasted output.
Variable costs do not always stay the same.
Most businesses sell more than one product, so break-even for the business becomes harder to calculate.
Be aware of these limitations. With that said, break-even analysis should be seen as a planning aid rather than a decision-making tool. It will help any business owner have a clear idea of how much needs to be achieved in sales to avoid a loss and make a profit.
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