Is your small business in the red, profitable, or perhaps somewhere in between? Whatever the financial status of your business venture today, the break-even point can help you improve upon it in the future.
Continue reading to learn the definition of the term and how to calculate the break-even point.
You might have heard the term "breaking even" used in personal finance to describe a point at which your expenses and income are equal. The term "break-even point" has a similar meaning in business accounting.
The break-even point refers to the point at which total revenue equals total cost. When a business has reached that point for a product or project, it has generated the product or project sales volume needed to cover both the fixed and variable costs of the business during a certain period of time.
The business incurs neither a profit nor a loss at the point of breaking even. The good news? This means your business did not spend more money than it pulled in for a venture. The bad news is that it did not make gains, either.
Calculating the break-even point, a process sometimes undertaken as part of a larger financial analysis, is useful for multiple reasons:
You can calculate the break-even point either in terms of units or sales dollars.
The formula based on units is:
Break-Even Point (in units) = Fixed Costs √∑ Contribution Margin
Let's take a look at an example. MileHigh Inc. wants to calculate its break-even point for a new widget. It estimates its fixed costs at $10,000, variable costs at $1.00 per unit of product and assigns a per-unit sales price of $5.00.
We can calculate the break-even point in units as follows:
$10,000 √∑ ($5.00 - $1.00)
$10,000 √∑ $4.00 = 2,500 units
Therefore, MileHigh Inc. needs to sell 2,500 widgets to cover its fixed and variable costs.
The break-even formula based on sales dollars is:
Break-Even Point (sales in dollars) = Fixed Costs √∑ Contribution Margin Ratio
Contribution Margin Ratio = Contribution Margin √∑ Per-Unit Sales Price
Using the same example above, we can calculate the break-even point in sales dollars as follows:
$10,000 √∑ ($4.00 / $5.00)
$10,000 √∑ $0.80 = $12,500
Therefore, MileHigh needs to sell $12,500 worth of widgets to cover its fixed and variable costs. As you might have noted, making $12,500 is the equivalent of selling 2,500 widgets as noted above. So while they use different variables, both formulas can be used to reach a similar conclusion about the financial prospects of a business venture.