Understanding what a break-even point (BEP) is and how it's important for your cost accounting or cost analysis is vital to your small business's success. In this article, we'll review what break-evens are, why they matter, and how to calculate your BEP.
Skynova's business accounting software can help you calculate your BEP by keeping all of your accounting information neat, organized, and easy to access from your computer or phone. With Skynova in your pocket, you might actually enjoy calculating your business's BEP.
What Is a Business Break-Even Point?
Your break-even point is the point at which you make enough money to cover the cost of running your business. You also need to understand break-evens to calculate the total revenue your business must have to make a profit. Break-even points and total revenue amounts are both related to your cash flow, or the relationship between what you spend and what you earn.
There are different equations to calculate your BEP, which we'll go over below. However, what each breaks down to is finding out how many units of an item you need to sell or how much money you need to bring in to "break even," covering both the costs of production and overhead, such as rent or property taxes. Looking at your break-even point lets you see how different factors, such as production costs, affect your bottom line.
Your break-even point is also important to know because it helps you set the prices at which you sell your product and lets you know how many products you'll need to sell to turn a profit. You'll look at all of your expenses, not just production costs, when calculating your BEP. Knowing how much your overhead costs you and the price-per-unit breakdown of the items you sell helps you keep an eye on the overall financial health of your business.
Preparing to Calculate a Break-Even Point
Like any financial analysis, preparing to calculate your break-even point begins with gathering all the necessary data. This includes any information related to the cost of purchasing or producing the items you sell, but it also involves more major expenses, such as the rent or mortgage for a storefront and employees' or executive salaries.
Along with these financial statements, you'll need a clear understanding of a few key accounting terms used when calculating your BEP.
Your variable costs, or variable expenses, are based on the purchase or production of the items you sell. As part of your cost of goods sold (COGS), these expenses are directly related to buying or manufacturing what you sell and any associated costs, like packaging or labor. These costs are called "variable" because they can vary much more than fixed costs. After all, it's easier to opt for more affordable packaging than it is to lower your rent, which is a fixed cost. Should you find that your break-even point is too high to reasonably achieve - meaning you'll have to sell quite a large number of units to offset the costs of production - your total variable costs will usually be what you look at first to bring your BEP within reach.
The fixed costs, or fixed expenses, in the equations below remain relatively the same from month to month or even year to year. These can include things like rent or mortgage payments if you have a storefront. You'll also include the wages you pay employees and managerial staff, should you have any. Also known as your business's overhead, these are the overall costs of operation, not just those of production.
Your contribution margin tells you how much of each sale goes toward paying your variable costs and how much is left over to cover the fixed costs. For a quick example, if a company sells a hat at $10 and it costs $3 to make each hat, the contribution margin of each sale is $7.
Your contribution margin ratio is also calculated from your sales and variable expenses, and it tells you what percentage of each sale is available to cover your fixed expenses. With that, you can also calculate your margin of safety (MOS), another percentage that shows how close your actual sales are to your break-even point. Calculating your profit margin is a similar process to see how much of a profit your business is actually making. However, for now, understanding the basic contribution margin calculation is enough to see you through the break-even point formulas below.
How Do You Calculate the Break-Even Point?
There are a couple of ways to calculate your BEP, either by looking at units or sales dollars. Whichever you choose, you can count on Skynova's accounting software to organize all of your business's financial information. Simplify your break-even point analyses with our easy-to-use templates and software.
Break-Even Point Formula in Units
One way to calculate your small business's break-even point is by finding how many units you need to sell to offset the costs of production. Naturally, businesses that sell tangible products will want to know this information, but even if your business is service-based, you can still calculate your BEP in units. Your billable hours will replace physical products and your costs will be like employee pay, transportation, and other operating costs associated with providing each hour of service.
You'll need to complete two simple equations to find your BEP:
|Revenue or Sales Price per Unit|
|− Variable Cost per Unit|
|= Contribution Margin|
|÷ Contribution Margin|
|= Break-Even Point (Number of Units)|
In this equation, you begin by deducting your variable costs from the sales price, which gives you your contribution margin or the amount you have left to cover your fixed costs from the sale of each unit. You then divide your fixed costs by the contribution margin to see how many units you need to sell to cover fixed costs, also known as your sales volume.
Break-Even Point Formula in Sales Dollars
Another way to calculate your break-even point is by looking at sales dollars rather than the number of units. Looking at your BEP this way helps you evaluate your pricing structure to see if you're charging enough money to cover your expenses. You can plug in monthly, quarterly, or even yearly costs and sales dollars into this formula to create an even larger financial image to examine.
|Price of Product|
|− Variable Costs|
|= Contribution Margin|
|÷ Contribution Margin|
|= Break-Even Point (Sales Dollars)|
Once again, you'll find your contribution margin and then divide your fixed costs by it. The end result is a BEP that tells you how much money you need to make. You can adjust the revenue or sales price to make that final number go up or down until you reach a BEP that seems reasonable for your business and its sales goals.
Examples of Break-Even Point Analysis
Let's look at some specific examples to see a break-even analysis in action. We'll use DIY Camping, a fictional small business specializing in outdoor equipment, to show how its owner will calculate a break-even point in units and then in sales dollars.
Calculating a Break-Even Point in Units
The owner of DIY Camping wants to start selling cross-country skis, a product they've never sold before. To know how many pairs of skis they need to sell to break even, they'll perform a break-even analysis.
Each pair of skis costs $25 to purchase, and the owner initially plans to sell them for $100. Using the above equation of sales price per unit minus the cost per unit, or $100 – $25, the owner finds their contribution margin to be $75. Their fixed costs include the salary for one employee, rent for the storefront, and utilities associated with running the store. These total about $20,000 a year. Plugging that into the second equation and dividing it by the $75 contribution margin, the owner's break-even point is a sales volume of about 267 units, or pairs of cross-country skis, per year.
Calculate a Break-Even Point in Sales Dollars
The owner of DIY Camping is concerned they won't sell 267 pairs of cross-country skis in a year. To bring the break-even point down to what feels like a more reasonable level, the owner performs a BEP analysis in sales dollars. This way, they can plug in a different selling price for the skis and find a more attainable sales volume.
This time, the owner decides to see what their BEP will look like if they charge $125 for a pair of skis. Since they still cost $25 to purchase for the store, her contribution margin equation is now $125 – $25 = $100. The owner now divides the fixed costs of $20,000 by $100. The break-even point is now $200.
This means the business needs to make $200 in sales to offset the cost of stocking those cross-country skis. If the skis are priced at $125, the owner only needs to sell two pairs to reach the BEP. This is a much more reasonable sales volume goal, so the business raises the initial sales price.
Let Skynova Help You With Your Small Business Accounting
A break-even analysis is something all small business owners need to perform on a regular basis, but how do you complete a BEP analysis if your financial information isn't easy to find? The answer is, you don't (or, at least, you don't do it well). Staying organized is an important part of running your business, and using Skynova's business accounting software makes staying on top of things incredibly easy.
Contribution margins, total expenses, and total sales are all simple to calculate when you have purchase receipts, sales receipts, and invoices right on your Skynova account. And while you may never actually call performing break-even point analyses "fun," they won't be the chore they used to be before Skynova. Our software products simplify your small business accounting tasks. Check out our templates and software today to run your business better.