Your business’s break-even point happens when revenues equal expenses exactly. You must keep the break-even point in mind because it shows how many sales you need to keep your business afloat and moving forward.
What is the Break-Even Point?
When you reach your sales targets, you may feel successful, but setting the right targets matters more in the long run. Your break-even point, or the moment when your total revenue equals your total expenses, proves one of the most important targets for small businesses to hit. At the break-even point, your company has neither lost nor made any money, and you have to sell past this target in order to turn a profit.
To find your break-even point, you first need to know your contribution margin, or your revenue minus your variable costs. To calculate your contribution margin percentage, divide your contribution margin by your total revenue.
Break-Even Point Variables and Formula
Calculate the break-even point using three distinct variables to determine how many items you need to sell to make a profit.
- Fixed costs such as rent or labour costs.
- Variable costs, which are costs that fluctuate such as sales volume, such as raw materials for products.
- Sales price of the product.
The formula to calculate your break-even point is:
Break-even point in units = fixed costs / (price – variable cost)
For example, you have $15,000 of fixed costs for the month. You sell a widget for $25, and each widget costs $5 to manufacture in terms of variable costs.
The break-even point in units for the month for your widgets breaks down to:
$15,000 / ($25 – $5) = $15,000 / $20 = 750 units
You company becomes profitable for the month once you sell 751st widget.
Other Considerations for the Break-Even Point
If your company sells more than one product, you need to calculate the break-even point for each product you sell. That’s because the variable costs for each product are different. Your company may sell the same product but it has different sizes or varieties. You need to calculate the break-even point for those varying sizes, because the price changes and more raw materials go into them.
Tweaking the price in the formula for the break-even point can make the number of units go up or down. For example, if you change the price of the widgets in the above example to $30, your formula would become: $15,000 / ($30 – $5) = $15,000 / $25 = 600 units. This reduces the number of units you need to sell by 150. However, raising the price may make customers think twice about buying your widgets. You can lower the price of the widgets, but you must make up for the lower price by having a higher volume.
The break-even point comes in handy for figuring out whether you want to launch a new product. You can also gauge how much you may need to invest in a product before you see a return on your investment.
Quick Tips on How to Calculate Your Break-Even Point
Use actual amounts rather than estimates
By using actuals you’re more likely to ensure the expense numbers are correct. For example, knowing you need $1,000 per month to cover your expenses allows you to create a plan of action to reach this specific target.
Use a ‘valley’ month as your time span
Generally, your small business has peaks (periods of higher revenue) and valleys (periods of lower revenue). If you calculate a breakeven over a 12-month period, you may underestimate the amount needed during the slow periods. Using a ‘valley’ month ensures that you cover all your expenses, no matter what stage you’re in at any point of the year.
Start with your fixed expenses
Examples of fixed expenses are rent/lease, insurance, amortization, interest expense, property taxes, and depreciation.
Don’t underestimate variable expenses
Examples of variable expenses are payment processing fees, commissions, and supplies. Over time, you get better at estimating your variable expenses, but during your company’s early stages, the easiest way to determine the variable expenses is to tie it to one unit of sales. Wondering what a unit of sales is? It’s a single time period that you use as a base for expenses and sales during it.
Watch out! It’s easy to overestimate revenue
Most small companies, like yours, overestimate the amount of sales to expect in a month. It’s beneficial to take a conservative stance when calculating expected sales to avoid setting goals that are too lofty for your early-stage operations. You can always adjust these numbers later when things stabilize and/or pick up. Again, use one unit of sale as your benchmark to estimate what is required in terms of time and resources.
QuickBooks Online lets you track expenses and run custom reports so you can gauge how fast it takes to meet your break-even point during any given month. That’s why 5.6 million customers use QuickBooks. Join them today to help your business thrive for free.