A lot of small business owners are currently wondering when their business will finally breakeven. A company's breakeven point is the demarcation between profit and loss; reaching it is a sign of the business’s viability. So it makes sense that it’s always on a business owner’s mind, whether their business is just launching or on the fast track to the next stage in its growth.
In this article, we’ll explain what a breakeven point is and how to calculate it.
Shortcuts
- What is the breakeven point?
- How to calculate the breakeven point
- Factors that affect breakeven point
What is the breakeven point?
The break even point (BEP) is the stage at which total revenue equals total costs, resulting in neither profit nor loss. It's a critical financial metric, especially for small businesses, as it helps determine the minimum output or sales needed to cover all fixed and variable costs.
Knowing a business’s breakeven point can help business owners make decisions and take actions like setting the price for their products and services, determining sales targets and profitability goals, and managing costs. Lenders and potential investors also examine a business’s breakeven point when deciding whether to approve a loan or invest capital.
Calculating breakeven points takes into account three key variables: fixed costs, variable costs, and sales volume.
- Fixed cost. These are expenses that don’t change with a business’s production or sales volume. They include rent, utilities, insurance, and office payroll. For ecommerce businesses, fees for developing and maintaining a website also would be considered fixed costs.
- Variable cost. These are costs directly associated with the production of goods or services, and which rise or fall with changes in the amount of production. Variable costs include raw materials and labor for production.
- Sales volume. This is the number of goods or services sold. Volume can be counted in total dollar amounts or by the number of product units sold.
How to calculate the breakeven point
Businesses can calculate breakeven points either in terms of the total dollar amount of sales or by the number of products, called unit sales.
Let’s look at unit sales first. The breakeven point formula for determining how many product units must be sold is:
breakeven point = total fixed costs / (product unit price - variable costs per unit)
Let’s take a hypothetical business, ABC Shipfast, which offers a product for a sales price of $200 per unit. Its variable costs for each product unit are $100, and its fixed costs each quarter are $5,000. The breakeven point then that quarter is:
breakeven point = $5,000 / ($200 - $100) = $5,000 / $100 = 50
ABC Shipfast needs to sell 50 of its products at $200 each to breakeven for the quarter. If it sells 51 or more, it makes a profit; if it sells 49 or fewer, it suffers a loss.
To determine a breakeven by total dollar sales, the formula is similar, but varies in the denominator:
breakeven point = total fixed costs / (contribution margin per unit / sale price per unit)
The contribution margin is product price minus variable costs per unit. It refers to how much each unit of product sales is contributing to a business’s marginal profit—the amount after production costs are subtracted.
So, for example, a product that has $5 in variable costs to produce, and is sold for $10, has a contribution margin of $10 - $5 = $5. Another product, also selling for $10 but with $7 in variable costs, has a smaller contribution margin of $3.
In the formula for determining a breakeven by total sales dollars, the denominator is called the contribution margin ratio, which is the contribution margin divided by the unit sale price.
In the same ABC Shipfast example, the contribution margin is $100, or $200 unit price minus $100 unit cost. So the contribution margin ratio is $100 divided by $200, or 0.5. So the quarterly breakeven for ABC Shipfast in dollar sales is:
breakeven point = $5,000 / ($100 / $200) = $5,000 / 0.5 = $10,000
The breakeven sales calculation shows if ABC’s sales are above $10,000 in the quarter, it begins to show a profit. Below $10,000, and it is losing money.
Factors that affect breakeven point
- Price of product or service
- Volume of sales
- Changes in fixed or variable costs
There are certain factors that affect a business’s breakeven point. Let’s consider our hypothetical case of ABC Shipfast to examine three of them:
1. Price of product or service
If ABC Shipfast raises its prices, assuming the other variables don’t change, its breakeven point would be lower. The inverse would be true if ABC lowered its product price. Let’s say ABC Shipfast raises its product price to $225 from $200. ABC would need to sell only 40 product units, not 50 (or generate only $9,000, not $10,000) to cover its costs.
2. Volume of sales
If ABC doesn’t change its prices or costs, the amount of products ABC sells determines its breakeven point. Every additional dollar of sales above the $10,000 breakeven, or unit sales above 50, is profit for the company, and vice versa for sales below breakeven. For example, if ABC’s sales rise to $11,000, or 55 units, it makes a total profit of $500.
3. Changes in fixed or variable costs
A reduction in variable costs would lower ABC’s breakeven point, making it easier for it to reach profitability. Higher costs would raise the bar for breakeven, making it harder to reach profitability. If ABC’s fixed costs dropped to $4,500 from $5,000, it would need to sell only 45 product units (or to make $9,000 in sales) to breakeven; if fixed costs rose to $5,500, it would need 55 unit sales (or sales of $11,000) to breakeven.
Breakeven point FAQ
How do I calculate the breakeven point?
The breakeven point can be calculated either in terms of total dollar sales or total product unit sales required for the business to breakeven. Breakeven for product unit sales is calculated by dividing a product’s fixed costs by the margin contribution, or the product’s per-unit price minus its production (variable) costs. Breakeven for dollar-volume sales is calculated by dividing the business’s fixed costs by its margin contribution ratio, which will be a fraction of the product price.
How is the breakeven point used in business decision-making?
The breakeven point tells owners how much they need to sell in order to cover all their costs and reach profitability. It may help owners decide whether to raise prices, cut costs, expand, or seek a loan or new investors.
What is an example of a breakeven point?
Consider an online seller of athletic shoes. Let’s say its monthly fixed costs are $2,500, its average selling price is $125 per pair of shoes, and its variable costs (what it pays to get shoes from a wholesaler) are $100 per pair. Its breakeven point will be its fixed costs ($2,500) divided by the margin per shoe ($25), or 100. The business therefore must sell 100 pairs of athletic shoes per month to cover all its costs in order to breakeven.
What happens when breakeven is reached?
At the breakeven point, a business is operating at neither a loss nor a profit. Beyond this point, more sales mean it starts to generate a profit. Below that, it’s operating at a loss.
What is breakeven analysis?
Breakeven analysis is a method to determine when a business will turn a profit—in other words, when its sales begin to exceed its expenses. Small businesses can use breakeven analysis to set sales goals, decide on the prices it will charge, and look for ways to cut expenses. Investors can use breakeven analysis when considering a possible new business venture, to assess how long it would take that venture to become profitable.
