Your break-even point is the point at which you break even. To put it another way, it is the point at which your sales cover your costs. You don’t turn a profit, but you also don’t lose anything. To calculate your break-even point, you can use a few different equations:
Fixed Costs / Contribution Margin = Break-Even Sales Dollars
Fixed Costs / Per Unit Contribution Price = Break-Even Units
To break it down, your fixed costs are the expenses you pay every month to keep your business running, and they include office rent, insurance premiums and similar costs. As explained above, your contribution margin is 1 minus your variable cost ratio, and the per unit contribution price is the amount each sale contributes to your business. In other words, it’s the sale price of your product minus its variable costs.
To give you an example, say your fixed costs are $10,000 per month. You sell pies for $20 each, and you spend $12 making each pie. Your variable cost ratio is $12 / $20 = 60%. That makes your contribution margin 40 percent. When you divide your fixed costs $10,000 by 40 percent, the result is $25,000. You need to make that amount of sales to break even every month. Then, to find out how many pies (units) you need to sell, you can divide this number by $20, which means you need to sell 1,250 pies.
If you want to find units straight off the bat, you take your fixed costs ($10,000) and divide that by your contribution rate. As you spend $12 making each pie and you sell each pie for $20, your contribution rate is $8. When you divide $10,000 by $8, you also get 1,250. Now you know that you need to sell that many pies to cover all your expenses.
That said, you need to use this formula carefully. It can be instrumental for helping you set sales targets, but it doesn’t work that well in situations where your fixed costs are constantly changing.