Break-Even Analysis: Formula and Calculation

To avoid this, look at a full year of expenses — not just your monthly bills. Spreading out annual or quarterly costs into a monthly average gives you a more accurate picture of what it truly takes to break even. In all these scenarios, break-even analysis is like a the main specific features of double entry bookkeeping system financial compass. It points you to the sales level needed for sustainability in each situation, helping you steer your business decisions. Many AOF clients use this kind of analysis with the help of business advisors to make prudent decisions as they grow. By analyzing the numbers first, you’ll feel more confident whether you’re deciding on a marketing budget, an expansion, or any big move.

Raise product prices

Break-even analysis helps owners and managers to determine the target to hit before turning a profit. First, let us give you a brief idea of what these numbers from General Motors’s Annual Report (or 10K) signify. For the number of units, we have taken the worldwide vehicle sales.

Contribution margin is the amount each sale adds to covering your fixed costs—and eventually, to your profit. It’s calculated by subtracting your variable cost per unit from the selling price per unit. For example, if you sell something for $50 and it costs you $30 in materials and labor, your contribution margin is $20.

Revenues (or sales) at Oil Change Co. are the amounts earned from servicing cars. Oil Change Co. charges one flat fee of $24 for performing the oil change service. For $24 the company changes the oil and filter, adds needed fluids, adds air to the tires, and inspects engine belts.

The gross sales for 2018 were $133,045MM, which, when divided by 8,384,000, gives a price per unit of $15,869. As such, this business must sell 334 candles monthly to break even. At this sales volume, the revenue ($8,350) exactly covers all fixed and variable costs, resulting in zero profit and zero loss. Some expenses look variable but aren’t — like a monthly phone bill that only changes if you go over the qualifying for a mortgage with child support arrears limit. For semi-variable costs (like utilities), split them into fixed and variable portions. And don’t forget to include your own salary as a fixed cost if you want to account for paying yourself.

• Thinking of buying new equipment, hiring staff, or launching a new product?
• For example, if your rent is $1,000, it stays $1,000 whether you serve 100 clients or none.
• He is considering introducing a new soft drink, called Sam’s Silly Soda.
• The Break Even Point is determined by the moment when the fixed costs have been earned back.

Informs Pricing Strategy

Traders can use break-even analysis to set realistic profit targets, manage risk, and make informed trading decisions. The contribution margin represents the revenue required to cover a business’ fixed costs and contribute to its profit. With the contribution margin calculation, a business can determine the break-even point and where it can begin earning a profit. Lowering variable costs or increasing the selling price can reduce the break-even point, making it easier to become profitable.

So, after deducting $10.00 from $20.00, the contribution margin comes out to $10.00. The break-even point is the point at which the total revenue equals the total fixed and variable costs. It’s an important metric for businesses to understand, as it helps them make informed decisions about pricing, production, and investment. The break-even point formula is calculated by dividing the total fixed costs of production by the price per unit goodwill as an intangible asset less the variable costs to produce the product.

You might also use it to model the effect on recruiting new staff or opening a new site as it will show how many more sales you’ll need to make to balance outgoings and income on any additional costs. A break-even analysis can provide essential information about the financial viability of your company. This is particularly important when you’re putting together financial projections or when you’re expanding your product lines.

By iterating like this, you can find an optimal path where your break-even is as low as possible and your business model remains attractive to customers. The break-even point (BEP) is the moment your business’s total revenue exactly covers its total costs. At break-even, you’re not losing money, but you’re not making a profit either – it’s the threshold where your business “breaks even” on expenses​. In practical terms, if your company’s break-even point is $50,000 in monthly sales, then at $50,000 you have paid all your bills and costs for the month, but you haven’t made a dime of profit yet. Every dollar beyond that is profit; every dollar below means a loss. This formula calculates the break-even point by dividing the fixed costs by the contribution margin (selling price – variable costs).

Fixed Costs – Fixed costs are ones that typically do not change, or change only slightly. Examples of fixed costs for a business are monthly utility expenses and rent. Now Barbara can go back to the board and say that the company must sell at least 2,500 units or the equivalent of $1,250,000 in sales before any profits are realized.

Step-by-Step Calculation Example

You’ll then need to separate your costs into your fixed costs and your variable costs. Like any mathematical formula, the break-even analysis is only as accurate as the details used to calculate it. Inaccurate variable and fixed costs will leave managers with an incorrect break-even quantity that doesn’t accurately reflect the company’s needs to turn a profit. To calculate the Break Even Sales ($) for which we will divide the total fixed cost by the contribution margin ratio. It means by selling up to 3000 units, XYZ Ltd will be in no loss and no profit situation and will overcome its fixed cost only.

How to Conduct Break-Even Analysis

Typical fixed costs include rent, executive salaries, and ERP software expenses. Unit contribution is the difference between price and average variable cost. The value of the unit contribution should be positive (price should be greater than average variable cost) in order to calculate the breakeven point. In breakeven analysis, average variable cost is assumed to be constant.

Step 1: Identify your fixed costs

Think for instance of salaries, monthly energy bills and the depreciation costs of current assets (including machines) and fixed assets (such as a building). Many run the numbers during quarterly planning, before launching a new product, or when costs or pricing change. When a new venture or business is going to start, break-even analysis is used to identify whether the idea of a startup is realistic in terms of cost or not. It also provides a basic pricing strategy to investors for their startups. To confirm this figure, you can take the 1818 units from the first calculation, and multiply that by the $1.50 sales price, to get the $2727 amount. Upon doing so, the number of units sold cell changes to 5,000, and our net profit is equal to zero.

• The value of the unit contribution should be positive (price should be greater than average variable cost) in order to calculate the breakeven point.
• Instead of applying one yearly break-even point, run the numbers for each season.
• He is the sole author of all the materials on AccountingCoach.com.
• In conclusion, just like the output for the goal seek approach in Excel, the implied units needed to be sold for the company to break even come out to 5k.

Planning for Slow Periods or Seasonality

Total variable costs go up and down depending on how many units the business creates. The break-even point is the moment your business covers all its costs. At this point, you’re not making a profit, but you’re not losing money either. In the second approach of break even analysis method, we have to divide the fixed cost by contribution to sales ratio or profit-volume ratio i.e.

Therefore, ABC Ltd has to manufacture and sell 100,000 widgets in order to cover its total expense, which consists of both fixed and variable costs. At this level of sales, ABC Ltd will not make any profit but will just break even. Break-even analysis helps businesses choose pricing strategies, and manage costs and operations. In stock and options trading, break-even analysis helps determine the minimum price movements required to cover trading costs and make a profit.

Once you know your break-even point, you can calculate your “margin of safety” — how far above break-even you are. If your monthly sales are $60,000 and your break-even is $50,000, you’ve got a $10,000 cushion. You can handle a dip in sales, try a risky campaign, or plan for a seasonal slowdown without panicking. Reaching this point (and moving beyond it) is a key measure of financial health.In fact, understanding break-even can be a gamechanger. By knowing exactly when you’ll stop losing money and start making it, you gain confidence to make informed decisions for your business’s future. These are often referred to as mixed expenses or semi-variable expenses.