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What is break-even analysis? How to calculate the break-even point and gain financial insights
Financial reports

What is break-even analysis? How to calculate the break-even point and gain financial insights

Running a small business can be a costly endeavour, and with cost always comes risk. As a small business owner, you might find challenges in measuring whether the risks and associated expenses are worth it. Is your small business profitable? If not now, will it ever be? How do you get there?

If you find yourself asking these questions, it’s time to dive deeper into your break-even point. This is an invaluable accounting concept that can help small business owners determine the point at which their business breaks even and what steps they might take to make it become profitable. 

Read on to learn all about how this accounting formula can serve your small business.

What is the break-even point?

The break-even point is a concept in accounting that helps business owners determine the profitability of their business. In the most basic sense, the break-even point is the point at which the cost of running your business equals the revenue generated by your business in a specified period of time.

If a business is at the precise break-even point, the business is running neither at a profit nor at a loss; it has simply broken even.

Why is break-even analysis important?

Break-even analysis is important because calculating your business’s break-even point allows you to determine how much more revenue your business needs to generate before you can reach profitability. Conversely, a break-even analysis can also help you determine how many costs you need to cut to reach profitability.

It may sound fruitless to determine a point that doesn’t portray a win or a loss, but simply a stasis. But the break-even point is an extremely useful calculation for any business looking to reach profitability.

For new businesses, break-even analysis can be a vital part of your business plan. It can help you determine your pricing strategy, cash flow and other important financial health indicators.

Factors that can help determine the break-even point include:

  • Fixed costs: costs that remain the same regardless of your sales volume, such as lease and rental payments or insurance payments
  • Variable costs: costs that fluctuate according to your sales volume and number of units sold, such as raw materials and product costs, or the costs associated with performing your service
  • Sales price: the selling price you’ve determined for your product or service
  • Sales volume: either unit sales or service volume

Break-even analysis: how to use the break-even point formula

The process of calculating a break-even point to determine the point of profitability is more commonly known as a break-even analysis.

You can calculate this in two ways: the break-even point in sales dollars or in number of units.

How to calculate the break-even point in sales dollars

Calculating the break-even point in sales dollars will tell you how much revenue you need to generate before your business breaks even.

The break-even analysis template for calculating the break-even point in sales dollars is as follows:

Break-even point (sales dollars) = fixed costs / contribution margin

illustration of break-even point formula in dollars, which reads “break-even point in sales dollars equals fixed costs divided by contribution margin”

The contribution margin is the profit of a single product or service. To find the contribution margin ratio, use the following formula:

Contribution margin = (sales price per unit - total variable costs per unit) / sales price per unit

illustration of contribution margin formula, which reads “Contribution margin equals (sales price per unit minus total variable costs per unit) divided by sales price per unit”
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Calculate break-even point in number of units

If you’d prefer to calculate how many units you need to sell before breaking even, you can use the number of units in your calculation. That formula is as follows:

Break-even point (units) = fixed costs / (sales price per unit - total variable costs per unit)

illustration of break-even point formula in units, which reads: “break-even point in units equals fixed costs divided by (revenue per unit minus variable cost per unit)

Break-even point analysis examples

Break-even analysis is an essential financial analysis for all businesses, from startups to established businesses looking to roll out a new product or increase total revenue. Let’s look at some examples of the break-even point in use.

chart shows example of break-even point

Calculating a break-even point in dollars sold

Let’s say your company has developed a new widget. You’re trying to determine the break-even point of your new business. Here’s what you know:

  • Fixed cost of running your business: $20,000 per quarter
  • Unit variable cost: $10
  • Proposed unit price: $30

First, you’ll need to calculate the contribution margin:

Contribution margin = ($30 / $10) / $30

The above formula calculates your contribution margin at $0.10

Then, to determine the break-even point in sales dollars, you calculate the following formula:

Break-even point (sales dollars) = $20,000 / $0.1

According to this formula, your break-even point will be $200,000 in sales revenue. To break even, you’ll need to generate $200,000 in revenue. Any money generated over that $200,000 will be net profit.

Compare this formula to your forecasted sales for the quarter. Will you break even on your revenue? If not, you may need to:

  • Increase your sales price
  • Increase your level of sales
  • Lower your variable cost per unit by lowering labour costs or raw materials costs.
illustration of graph, with the text “If you do not break even on revenue, you may need to: increase your sales price, increase your level of sales, lower your variable cost per unit”

Using break-even point to determine level of production

Let's say you’re trying to determine how many units of your widget you need to produce and sell to break even. Again, here’s what we know about your business:

  • Fixed cost of running your business: $20,000 per quarter
  • Unit variable cost: $10
  • Proposed unit price per unit sold: $30

To determine our break-even point in units, we’ll calculate the following:

Break-even point (units) = $20,000 / ($30 - $10)

According to the above formula, you’ll need to generate and sell 1,000 units to break even. Any more than that will generate profit. How does that compare to your total sales forecast? If the units sold to break even is greater than your forecasted sales volume, you may want to:

  • Increase your level of sales
  • Increase your unit production by increasing direct labour.

Performing a break-even analysis can give you insight into many different elements of your business. It can help you understand the following:

  • Is a product’s price realistic? If you won’t be able to reach the break-even point based on your current price, you may want to increase it.
  • Are your labour costs too high? If your product is so expensive to make that your contribution margin simply isn’t working out, you may need to bring down labour costs.
  • Is a product worth bringing to market? If the demand for your product is smaller than the number of units you’ll need to sell to break even, it may not be worth bringing the product to market at all.

As a small business owner, there are so many risks that you take each day. The best way to protect yourself and your business is by limiting your risk. Break-even analysis is an important way to help calculate the risks involved in your endeavour and determine whether they’re worthwhile before you invest in the process.

If you’re looking for other small business tips and financial reporting tools, we’re here to help. QuickBooks can assist with all small business accounting needs, from bookkeeping and reporting to managing invoices. Contact us today to discover what QuickBooks can do to help you and your small business.

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