Everyone wants their business to make profits. However, if you are starting a business now, it might be a few years until you enter the profit territory.
Even then, you might be stuck at the break-even point for a while. So it is vital to understand all about the break-even point and how you can calculate it.
What is a break-even point?
When your business reaches a break-even point, it means that your expenses are equal to sales. This means the amount of money you are gaining is equal to the amount of money needed for all the expenses required to run the business. When you break even, your company will not have any profits or losses.
If you have reached the break-even point for the first time in your business career, it is a positive sign. This means that you are finally able to make money that will cover all your expenses.
Understanding the break-even point will let you know if you need to do any one or both of the following
- Increase your product and services prices or,
- Cut down on your expenses tactically.
If the business revenue is under the break-even point, your business is at loss; if it is above, you are surely making profits. Use the break-even point to determine how much money you need to make to cover all your expenses while making profits.
Additionally, this calculation will help you set a budget plan, control your expenses, and manage your business and machinery loans while devising a pricing strategy.
Break-even point formula calculation
To learn what the break-even point for your business is, you need to know the break-even point formula, which is explained below. You need the following three values to calculate the break-even point
- Fixed costs,
- Variable costs and
- The selling price of the products
You might be wondering what the difference between fixed and variable costs is. Fixed costs are the expenses that you have to bear irrespective of the sales you make. These costs remain the same all the time, which are paid to run your business, such as rent expenses and insurance.
On the other hand, the variable cost is dependent on the sales activity of your business. If the sales activity increases, then the variable costs increase. Direct materials and direct labor come under variable costs.
Your selling price is simply the cost of a single unit of product. The following is the formula used to calculate the break-even point.
The break-even point for a single unit = Fixed costs / (Selling price per unit – Variable cost per unit)
The value obtained by subtracting variable costs per unit gives us the contribution margin. The Contribution margin will tell us the amount of money you will take home as profit from a sale.
So, the break-even point of your business is the value of fixed cost divided by contribution margin. You need to be aware that the contribution margin is calculated with the values of selling price and variable costs per unit.
Why you should not neglect break-even analysis
Though this may seem like a simple math problem, analyzing your business sales with this formula has many benefits. Some of them are mentioned below.
- Better pricing: Finding the break-even point of your business will make you understand if the price of your products is reasonable or too pricey, or too low. With this point in mind, you can price your products in a better way. Although a lot of psychological thinking is put into effective pricing, understanding its effects on your products is just as important. You should be able to pay your bills with the help of your business and not drown in losses due to the low pricing of your products.
- Cover all the fixed costs: When you think about pricing, the first thought that goes into mind is the cost of production. This cost is the variable cost that varies from product to product. However, covering variable costs with your pricing range is not sufficient. You need to be able to handle your fixed costs like the insurance and loan repayment expenses if you have taken any business loans or machinery loans. Break-even analysis will help you with that.
- Set a revenue target: If you are working on improving your business day and night without a goal in mind, you will reach nowhere. You need to understand what you are working for. Once you have finished the break-even analysis, you will know how much you need to make to gain profits. With that information, you can set a target to reach. Explaining the goal to your team will make it easy to work towards it.
- Make smart choices: Entrepreneurs often tend to make decisions based on their emotions. If a new venture feels good and simple, they go for it. Doing what you like is important to have a happy life, but it is not enough to profit. If you want to be successful, you should make your choices based on the available facts. With the break-even analysis, you will be able to understand if you can dive into a new venture without losses or not.
- Limit financial difficulties: With the break-even value in your mind, you will understand your position in terms of money-making. You will know if it is safe to venture out or to experiment with your business or not.
- Business fundings: If you find yourself in losses after calculating the break-even point, it is easy to take measures and regain your business. You can choose to take an MSME loan and help boost the production of items or take a machinery loan and improve the equipment value to enhance production quality. Instead, if you ignore the analysis of the income, then you will not even be aware of the losses, and after a while, it will be too late to save your business.
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Frequently Asked Questions
Your break-even point is the point at which total revenue equals total costs or expenses. At this point there is no profit or loss — in other words, you ‘break even’.
To calculate the break-even point in units use the formula: Break-Even point (units) = Fixed Costs ÷ (Sales price per unit – Variable costs per unit) or in sales dollars using the formula: Break-Even point (sales dollars) = Fixed Costs ÷ Contribution Margin.
For example, selling 10,000 units would generate 10,000 x $12 = $120,000 in revenue. If the company sells 10,000 units, the company would incur 10,000 x $2 = $20,000 in variable costs and $100,000 in fixed costs for total costs of $120,000. The break even point is at 10,000 units.
The break-even point (BE) is the number of sales needed to earn zero profit — enough sales so that you don’t earn a loss, but insufficient sales to earn a profit.
For example, if the optimal target for your strategy is 12 ticks, and the optimal stop-loss is 10 ticks, the break-even percentage is 45% (10 / (12+10)). This means that 45% of the trades that are taken must be winning trades for the trading system to break even.