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How to Calculate the Break-Even Point for Your Business

Finance
Article
04/08/2015

As a small business owner, it’s important to understand what it means to break even and how to calculate the break-even point to determine whether or not your business is making a profit. Be careful not to confuse generating revenue with making a profit, as well as the difference between a net profit versus a gross margin and the difference between fixed-costs versus variable costs (both of which are needed to calculate the break-even point.)

When a business reaches the break-even point, (which is also referred to as the point of breakeven) the business is no longer operating at a loss. It’s not operating at a profit either, but it is no longer losing money. The term break-even is normally associated with startups, but it’s often used in established businesses as well.

The point of break-even can be looked at in two ways:

  1. When the initial cash needed to fund a new business or venture (such as a business loan or investment) is no longer needed to sustain the business. In this case, there is sufficient revenue to cover the fixed and variable cost and the cash balance is $0.
  2. When a company is not operating at a profit or at a loss and the net income is $0.

In either case, a business can reach its break-even point when sales reach a certain level and can become profitable as sales increase. It’s important to find out how much revenue needs to be generated to operate beyond the break-even point and become profitable, as well as monitor your revenue levels on a regular basis.

Is your small business breaking even but barely getting by? Or are you operating just beyond the break-even point? There are some simple steps that you can take to help you monitor your business’ ongoing monthly sales and profits.

What you need to know about the break-even point

At its simplest, the point of break-even is the point where you are earning as much as you are spending — no more, no less. Although breaking even is better than operating at a loss, operating beyond the break-even point is where business owners want to be. It allows them to: a) begin to realize profits, and b) see signs of growth and stability. Performing a break-even analysis allows you to determine when you will likely begin generating a profit and where your sales levels need to be to maintain profitability on a monthly basis. This process can be simplified with the use of a good cloud-based accounting system, allowing you to monitor increases and decreases in sales.

Calculating the break-even point

A simple formula to calculate the break-even point for your business is:

Break-even point = fixed costs / (unit selling price - variable costs)

Let’s take a closer look at this formula’s components by using an example of t-shirt sales:

  • Fixed Cost – This consists of costs that remain the same regardless of how much is generated from monthly sales, such as rent expense, salaries, insurance, and other ongoing, general office and administrative expenses. For our t-shirt example, we’ll use $10,000 as the monthly fixed cost.
  • Unit Selling Price – This is the price that your product is sold for. In this example, $25 is our selling price for each t-shirt.
  • Variable Cost – This not only includes the cost of the t-shirt, but other costs, such as shipping and delivery. For this example, it costs $10 to purchase/manufacture the t-shirt, plus $3.50 for shipping, making the total variable cost per unit $13.50.

Based on the break-even calculator, 869.6 units would need to be sold each month to break even and $21,739.13 would need to be made every month in sales:

Break-even point = fixed costs / (unit selling price - variable costs)

Fixed costs / (unit selling price - variable costs) = 10,000 / (25 - 13.50) = 869.9 units

Break-even point = 870 units or $21,750 in sales revenue

To generate a profit and operate beyond the point of breakeven, unit and monthly sales would need to be greater than 870 units or $21,750 in sales revenue. When sales are lower, the t-shirt company in our example would be operating at a loss.

Following these simple steps will allow you to perform a break-even analysis and determine how much you need to generate in sales for your own business to become profitable.

 

This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.
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