What Is Break-Even Point Formula and Why You Should Use It?
You may have heard of the term “break-even” a lot of times. In simple words, it is the stage when your net profit and net loss are zero. Or it is the stage when your profits cover the business expense. Knowing your break-even point is crucial for several business decisions at different stages, especially at the start. Before making it big, an important stage for a business is when it generates enough revenue to cover its expense. For instance, Call center vista can create a working strategy for long-term sustainability using the break-even point formula.
In this blog, you can get a detailed knowledge of this formula so you can use it for business planning.
Important Terms to Understand for Break-Even Point Formula
There are a few things you should know to understand the break-even point formula. These terms are as follows:
The fixed costs or fixed expenses are the ones that you have to pay every month regardless of the number of units sold. For example, the rent of the physical stores and storage facilities, computers, bills of utilities, and other payables. In the case of online stores, those fixed costs will be your hosting fees. Some other fixed costs to consider can be estimated marketing and sales expenses.
The price of a product is the one you are going to charge for a singular unit. Generally, the profits earned from the products are the ones that cover all the running expenses of the business including the labor and material costs. Therefore, it is best to factor in all aspects, including profits, before setting a price.
Variable costs are the ones you pay for the production of a product. These prices are the sum of material costs, labor, and other necessary expenses to make a product ready for retail.
The contribution margin is the result of subtracting the variable costs from the product price. The rest you are left with is your contribution margin from a unit product. The contribution margin of collective products should be good enough to cover fixed expenses and generate profits.
If you have something left after subtracting the fixed expense from the contribution margin, those are your profits. Similarly, if you need money to cover fixed expenses, that amount is your loss.
Calculations to Determine Break-Even Point
To calculate the break-even point, you need to know the formula. It is quite straightforward and has multiple variations. Such variations can help you with calculations in different models and industries. For example, the calculation for the break-even formula for two businesses dealing in products and services is likely to differ. It is because not all businesses are the same. For example, businesses dealing in regular products and custom ones may have to use different types of calculations.
Regardless of the nature of the business, the following simplified formula applies in every case:
Break-Even Point = Fixed Costs / Contribution Margin
Check out two more detailed break-even point formulas in the following:
Break-Even Point Based on Product Units
Applying the per unit calculation is quite easy. It tells you how many units you have to sell to break even. The units you sell after that number result in earning you profits. Here’s what the break-even formula looks like for product units:
Break-Even (Number of Units) = (Fixed Costs) / (Earned Revenue for Unit Product – Variable Cost for Unit Product)
Also Read: All You Need to Know About App Wrapping
Break-Even Point Based on Cash
You can also calculate the cash you need to earn to break even using the same formula with slight adjustments. Here is how you can calculate the break-even point for cash earned:
Break-Even (Cash You Need) = Fixed Costs / Contribution Margin
The results will show you the cash you need to break even.
Benefits of Applying Break-Even Formula and Break-Even Analysis
The break-even formula has several uses. This simple formula tells you how sustainable your business model is. At different stages of a business starting from the startup to launching new products, you can know how many units you need to sell. On top of that, it helps with pricing your products for profitability.
Applying the break-even point formula to your business is called break-even analysis. And this analysis tests your guesses about the different profit-earning aspects. Thus, using this formula is highly advisable.
The break-even formula helps you know what you need to break even. However, this one formula can help you in many departments, like setting outbound sales targets. Further, it may help businesses discover ways to reduce variable costs and maximize profits.
The break-even point formula tells you how you can make a business profitable and helps with deciding product prices. Here’s how to calculate it. Method facilitates you recognize what you want to interrupt even. However, this one method let you in lots of departments, like placing outbound income targets. Further, it could assist corporations learn how to lessen variable expenses and maximize your business and grow exponentially.