How small business calculates break-even point

Manasa Reddigari

May 8, 2019

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.

What's a 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.

Why should small businesses know their break-even point?

Calculating the break-even point, a process sometimes undertaken as part of a larger financial analysis, is useful for multiple reasons:

It tells you how many units of a business offering you need to sell to avoid losses.
It helps you forecast when you will turn a profit.
Fixed and variable costs are identified and controlled.
It helps you identify whether or not your per-unit selling price needs adjustment.
It helps you assess your margin of safety. This figure amounts to actual sales minus break-even sales, which tells you much sales could still fall before a venture turns unprofitable).
The viability and risk of a venture before undertaking it is assessed.
It can easily and quickly be calculated.

How to calculate a break-even point

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

Contribution Margin = Per-Unit Sales Price - Variable Costs
Fixed costs are those that don't change as sales volume changes (e.g., insurance or rent)
Variable costs change based on sales volume (e.g., labor, material and manufacturing costs)

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

where

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.