Break-even analysis: Calculating the break-even point to gain financial insights

Running a small business can be a costly endeavor, 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 business plan sustainable? 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 perform break-even analysis. Read on to learn all about how break-even analysis can serve your small business.

• What is break-even analysis?
• Benefits of break-even analysis?
• Factors used in break-even analysis
• How to calculate the break-even point
• Break-even point formula in sales dollars
• Break-even point formula in number of units
• Performing a break-even analysis
• Limitations of break-even analysis
• When to use break-even analysis
• Tips for lowering the break-even point

What is break-even analysis? 

Break-even analysis, also known as break-even point analysis, involves calculating the point at which a business breaks even and what steps it might take to become profitable. This “point” is known as the break-even point. 

The break-even point (BEP) is the point at which the costs of running your business equals the amount of revenue generated by your business in a specified period of time. In other words, your company is neither making money nor losing it. 

Break-even analysis can be broken down into two parts: 

1. Calculating the break-even point 
2. Analyzing profitability based off of the break-even point calculation

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

Benefits of break-even analysis

Whether you're an existing business or just starting out with a new business idea, performing break-even analysis is a great way to learn more about your business’s financial performance and make sure you’re budgeting effectively. Here are four ways businesses can benefit from break-even analysis.

1. Determine profitability 

The biggest use for break-even analysis is to determine whether or not your company is breaking even. Finding the break-even point of your business allows you to determine how much more revenue you need to generate in order to reach a profit. Conversely, it can also help you determine how many costs you need to cut to reach profitability. Out of the several ways to measure your business’s profitability, calculating the break-even point is one of the most simplistic. 

2. Set future budgets

Break-even analysis is great for entrepreneurs or companies that are just starting out and unsure of what to sell, how much to sell, or where to allocate their budget. This simple analysis can help that decision-making process by determining how much product you’ll need to sell to be profitable and how long that product will last. You can adjust variables, fixed costs, sales price, and volume metrics in each analysis to determine how much to budget for each of those costs.

3. Mitigate financial risks

Running a small business is all about taking risks. Should you bring a product onto the market? Should you pull one off? Break-even analysis can help determine those answers before you make any big decisions. For example, if the demand for your product is smaller than the number of units you’ll need to sell to breakeven, it may not be worth bringing the product to market at all. Finding your break-even point gives you a better idea of which risks are really worth taking.

4. Price products accurately 

Once you’ve determined your break-even point, you’ll be able easily view how many products you need to sell and how much you’ll need to sell them for in order to be profitable. If you won’t be able to reach the break-even point based on the current price, it may be an indicator that you need to increase it. This is beneficial for businesses that have been selling the same product at the same price point for years or businesses that are just beginning and are unsure of how to price their product.

Factors used in break-even analysis

In order to perform break-even analysis, you’ll need to be aware of the following factors:

• 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
• Contribution margin: the profit of a single product or service

How to calculate the break-even point

Before you can begin your break-even analysis, you’ll first need to determine your business’s break-even point. The break-even point can be found by using one of two formulas: 

1. Break-even point formula in sales dollars 
2. Break-even point formula in number of units

Calculating 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 point formula in sales dollars is:

Break-even point (sales dollars) = fixed costs ÷ 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

Calculating the 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. 

The break-even point formula in number of units is: 

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

Once you’ve decided whether you want to find your break-even point in sales dollars or units, you can then begin your analysis. 

Performing break-even analysis: The break-even point in action

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. Here are two examples of the break-even analysis template in use:

Break-even analysis using sales dollars

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

1. Calculate the contribution margin 

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

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

The above formula calculates your contribution margin at $0.10.

2. Plug your fixed costs and contribution margin into the break-even point in sales dollars formula

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

In this scenario, that formula will look like this:

Break-even point (sales dollars) = $20,000 ÷ $0.10

According to this formula, your break-even point will be $200,000 in sales revenue. This analysis shows that any money generated over $200,000 will be net profit.

3. Compare results to your forecasted sales 

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 labor costs or raw materials cost

Using break-even analysis 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 costs of running your business: $20,000 per quarter
• Unit variable cost: $10
• Proposed unit price per unit sold: $30

1. Plug your data into the break-even point in units formula

Remember, the formula for the break-even point in units is:

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

In this scenario, we’ll calculate the following:

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

2. Compare results to your forecasted sales 

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 labor

Limitations of break-even analysis

Even though break-even analysis can help forge a path to profitability, it’s not a perfect analytical tool. Let’s take a look at some of its limitations.

External factors aren’t considered 

Break-even analysis looks at internal costs and revenues, but doesn’t factor in external influences that can impact your business. — e.g., changes in market demand, economic conditions, inflation, supply chain disruptions, etc. For instance, if shipping costs rise due to global supply chain problems, your variable costs might go up and can throw off your original calculation. Similarly, If a competitor starts offering big discounts, your projected sales might drop and may cause you to miss your break-even point.

Focus on a single product or service

Typically, this analysis works best for businesses that focus on a single product or service. The analysis becomes more complex and less accurate if you offer a wide range of products with different price points and variable costs. For example, If you sell both high-end electronics and low-cost accessories, a single break-even analysis won’t account for the differing profit margins. You’d need individual analyses for each product category to get a more accurate picture of your profitability.

Not great for long-term planning

Break-even analysis works well for short-term planning, like setting immediate sales goals or dedication to prices. However, it’s not designed for long-term business planning. Let’s say you run a small bakery and plan to expand the bakery by opening a second location next year. Your break-even analysis alone won’t factor in the increased rent, higher utility bills, or additional staff wages. In this situation, it’s best to use forecasting tools like financial projections or budgeting software to account for future expenses and revenue growth.

Assumes constant selling prices

One limitation of break-even analysis is that it assumes selling prices will stay the same over time. In reality, prices often fluctuate due to market conditions, competition, or changes in demand. For example, if you run a café, you might decide to lower the price of your best-selling drink to attract more customers. While this could boost foot traffic, it also means your break-even point will change and you’ll need to sell more drinks to reach profitability.

When to use break-even analysis

Now that you know some of the benefits and limitations of break-even analysis, you might wonder when it’s best to use it. Here are a few scenarios where you could use it to your advantage:

Starting a new business

When starting a new business, this analysis can help you find out if your business idea is financially viable before you invest too much time or money. For example, If your startup costs are $50,000 and your product sells for $50 with a $20 production cost, break-even analysis shows you’ll need to sell roughly 1,700 units to cover your expenses. From there, you can decide on pricing, production, and sales targets so your business can stay on the right track from the get-go.

Introducing a new product or service 

Launching a new product or service can be exciting but equally intimidating, especially when you're unsure how much you’ll need to sell to cover your costs. This is where a break-even analysis comes in handy. It helps you figure out how many units you need to sell or services you need to provide to make sure your investment pays off. For instance, if your restaurant is introducing a new signature dish, you’ll want to know how many orders of that dish you need to sell to cover the costs of ingredients, staff time, and marketing.

Lowering your prices

Looking to beat a competing business? One strategy is to lower your prices to potentially bring in more customers. However, cutting prices can affect your profit margins. Before lowering your prices, it's a good idea to conduct a break-even analysis to see how much more volume you’ll need to sell to make up for the lower price. Here’s an example: If you reduce the price of a product from $50 to $40, but the cost to produce it remains $20, you’ll need to sell 25% more units to make up for the lower margin. 

Securing investors

When it comes to securing investors, especially starting out, they want to see that you’ve done your homework and understand how your business will make money. This is where break-even analysis becomes a valuable tool. It shows potential investors how much you need to sell to cover your costs and when they can expect to see returns on their investment.

Benchmarking performance

Break-even analysis can also be a great way to measure and benchmark your business's performance over time. Say your break-even is 300 units per month. Over the past couple of months, you’ve consistently sold 400 units, meaning you’re exceeding your goal and generating profit. On the other hand, if you’re only selling 250 units, you’ll need to either increase sales or lower costs to hit that target. Tracking this data over time can help you identify patterns — e.g., slower sales during specific months — so you can adjust your strategy based on those trends.

Tips for lowering the break-even point 

When analyzing your break-even point, not only do you want to see that your business is breaking even, you’re looking to make sure your business is profitable as well. Here are a few ways to lower your break-even point and increase your profit margin.

Increase product prices

If you won’t be able to reach the break-even point based on your current price, you may want to increase it. Increasing the sales price of your items may seem like an impossible task. Does the product have that type of demand? Will the financial risk be worth the possible gain? For many businesses, the answer to both of these questions is yes. 

By raising your sales price, you're in turn raising the contribution price of each unit and lowering the number of units needed to break even. With less units to sell, you lower that financial risk and instantly boost your cash flow.

Outsource fixed costs 

When you outsource fixed costs, these costs are turned into variable costs. Variable costs are incurred only when a sale is made, meaning you only pay for what you need. Outsourcing these nonessential costs will lower your profit margin and require you to sell fewer products to make a profit. 

Fixed costs that can be outsourced include: 

• Administrative work 
• Developers or designers 
• Manufacturers 
• Salespeople 

Reduce variable costs 

By reducing variable costs, or direct costs associated with the product, you’re increasing the contribution margin of your sales and the margin of safety of your business. A major way to reduce these costs is to redesign your product with less expensive materials. However, reducing variable costs doesn’t have to mean reinventing the wheel. 

A few simple ways you can reduce your variable costs are: 

• Redesigning the product with different materials
• Removing unnecessary production supplies
• Reducing production time 
• Lowering overall labor costs

Don’t leave your profitability to chance

As a small business owner, there are risks you take every day. Break-even analysis is an important way to help calculate the risks involved in your endeavor and determine whether they’re worthwhile before you invest in the process.

If you’re looking for other small business tips and accounting tools, we’re here to help. QuickBooks can assist with tasks from bookkeeping and payroll to inventory analysis and profitability. Contact us today to discover what QuickBooks can do to help you with all of your small business accounting needs.