Break-even point: definition and calculation
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If you’re trying to determine when your new business will start making a profit, then the break-even point (BEP) is the crucial metric for you, as it serves as a basis for profit planning and control within a company. To calculate your BEP, you need to conduct a break-even analysis.
Read on to discover the formula for the break-even point, what you should pay attention to in a break-even analysis, and why production can sometimes be worthwhile even if you don’t surpass the break-even threshold.
Break-even point: definition
The break-even point (BEP) is also known as the cost-covering point or the profit threshold. As a key performance indicator (KPI), it represents the point at which a company’s total revenues (including sales revenue) and expenses balance each other out. At the break-even point, total revenue and total costs are equal: no profit is generated yet, but losses are no longer incurred.
For entrepreneurs or new product providers, the break-even point is an important metric to determine when a new economic venture becomes profitable. If the break-even point is surpassed, you start to generate a profit. If the profit threshold is reached too late or not at all, the project may not be viable, so it’s important to understand your gross and net profits and revenue targets.
Break-even point: a graphical representation
At the break-even point, revenue and costs are equal. This can be visualized graphically: total costs, consisting of fixed and variable costs, can be drawn as a straight red line. Revenue is also represented as a line, this one green. The point where both lines meet is your break-even point.
The break-even point indicates the sales volume at which your revenue exactly matches the costs you have invested. For the period considered, the result is zero, meaning that there is neither profit nor loss.
Costs are divided into fixed costs and variable costs.
Fixed costs are incurred to enable the general offering of the product or service.
Variable costs depend on the output quantity, i.e., how many units of your product you produce.
To reach the break-even point, the selling price must exceed the variable costs. Then, each unit sold contributes, minus the variable costs, to cover the fixed costs – this surplus is the contribution margin and the proportion it makes up of costs is the contribution margin ratio.
The break-even point, therefore, marks a specific minimum sales volume or a certain number of goods sold. Alternative terms for the break-even point include:
Cost threshold
Profit point
Profit threshold
Cost-covering point
Why you need to calculate your break-even point
Before founding a startup, investing in a product, or starting a business idea, you need to estimate when your venture will pay off. This serves both to assess your own risk and to secure financing. The break-even analysis is the first of three steps in this process.
First, you determine the sales volume needed to cover the costs of production and to enter the profit zone through the break-even point.
Then, with a market analysis, you can assess how realistic it is to achieve this projected sales volume. What marketing and advertising efforts are necessary? What partners and intermediaries do you need, and what portion of your profit margin will you give up?
Any costs and revenue reductions that arise change the calculation of the break-even point once again.
The break-even point is a fundamental piece of information for your price calculation. Even a small change in the selling price, depending on the sales volume, can significantly lower the break-even point and increase the profit considerably.
The exact information on when and how you reach the break-even point is crucial for a business plan. Banks, venture capitalists and funding institutions require these details when companies apply for financing.
Entrepreneurs should be able to explain precisely when they’ll reach the profit zone in different scenarios and with what measures and under what conditions, chances and risks this can be achieved.
The break-even point formula: calculating the profit threshold
You calculate the break-even point using a simple formula. You need the following information:
Fixed costs
Variable costs
Selling price
The following formula is what you would use to calculate the break-even point:
x = C(f) / P – C(v)
Where:
C(f) are fixed costs
C(v) are variable costs
P is the selling price
By inserting the specific values, you calculate x, the exact sales volume at which you reach the break-even point. You can use a simple Excel spreadsheet for your own calculations.
The break-even analysis
Calculating without special cases is straightforward. However, the reality of running a business is rarely simple. There are usually many factors that influence the break-even point and each other.
To get a clear picture, you can conduct a comprehensive break-even analysis, where you consider various scenarios, the fixed costs, variable costs and the impact of different selling prices. Conducting this analysis will help you find different ways to reach the profit zone with minimal risk.
Analyzing fixed costs
The most significant fixed cost item is often personnel costs. If you’re self-employed, be sure to include your own salary. It’s a common mistake for inexperienced entrepreneurs to underestimate what they need for personal expenses including health insurance, retirement savings and reserves.
Other fixed costs vary depending on the product. For solo self-employed people, investments are often limited to a laptop, essential software subscriptions and an internet connection. An industrial company pays for production and storage facilities, machinery and technical equipment. Retail brands often have very high advertising and marketing budgets.
Step-fixed costs make calculating the break-even point more complex. These costs arise when you need to make additional investments after reaching a certain production volume, e.g., for larger production areas, additional equipment, or more staff.
Allocating fixed costs isn’t always straightforward, especially if your company has a broader range of offerings. Some fixed costs can be clearly assigned to individual products. Others, such as personnel costs, brand development or the costs of corporate headquarters, are fixed costs at the corporate level. These costs can be allocated to individual products proportionally, based on the product’s share of total sales.
Analyzing variable costs
Variable costs are incurred per unit or product. These might include labor, parts and raw materials, as well as other expenses related to service delivery such as packaging and shipping or travel costs.
Variable unit costs are not always stable. Scale effects can lower unit costs, making high volumes more economical than small series. For large quantities, alternative production technologies can become economically viable and abruptly reduce unit costs.
A regular break-even analysis
You shouldn’t perform this analysis just once and rely on the results indefinitely. You should reassess the profitability of individual products periodically, especially if:
Sales volumes or significant cost positions change
Your product portfolio changes
The shares of each product in total sales shift
With this approach, you always know the sales volumes you need to achieve to operate economically.
Not every product must reach the break-even point
Ideally, from an economic perspective, you wouldn’t offer products that won’t reach the break-even point. However, sometimes this may still be sensible.
For example, customers might only buy from you if you offer a full range of industry-standard products. This range often includes items that make you no profit. If you consistently delist these items, you become less attractive to your target audience, which could also reduce sales of profitable products.
Another example is the mixed calculation common in the publishing industry. A rule of thumb is that out of ten books, seven will flop, two will break even, and one will become a bestseller that alone finances the entire program.
Why then, do publishers not produce only bestsellers? Because it’s not foreseeable which title will perform well. Also, long-term thinking publishers cultivate their own market by also promoting exotics and emerging authors, giving space to unusual ideas and thus preparing the field for the next unexpected bestseller – many famous authors didn’t achieve success with their first novel, or even their second or third.
The break-even point: a practical example
Let’s use the example of a small business owner’s coffee stand to provide a practical example of how you use the break-even point to ensure cash flow.
The entrepreneur has paid off her loan and serves an average of 150 customers per day. She sees an opportunity to offer cake with a coffee. To do this, she plans to hire a baker part time for $520 a month.
The entrepreneur wants to run a break-point analysis to evaluate whether this step is worth it for each of the two cakes she wants to offer.
To do this, she first records the price data of the cakes in sales dollars:
| Cake | Chocolate Cake | Red Velvet Cake |
| Sales price per unit | $3.10 | $3.40 |
Variable costs per unit | $0.33 | $0.41 |
| Total fixed costs | $520 | $520 |
The break-even point chocolate cake for the chocolate cake:
$520 / ($3.10 − 0.33) = 188 units/month
The number of units that this corresponds to is 11.75 per day (for 16 working days per month).
The break-even point for the red velvet cake:
$520 / ($3.40 − 0.41) = 174 units/month
The number of units that this corresponds to is 10.88 per day.
The business owner assumes that around a fifth of her customers would buy a piece of cake with their coffee. If she achieves her estimated sales volume of 30 units per day, she’ll achieve well above the break-even point for both types of cake.
She decides to hire the baker. First, she decides to offer the cake with a lower break-even point to check whether her assumptions about sales are correct.
A simple calculation example without step-fixed costs
Let’s continue with the example of a mobile coffee stand. Fixed costs in dollars incurred monthly include equipment financing and the entrepreneur’s salary:
Loan payment: $200
Entrepreneur’s salary: $2,500
Thus, the annual fixed costs are $32,400.
For simplicity, there is only one product variant. The variable costs amount to 50 cents per serving.
The net selling price is $2.50 per serving.
Thus, the simple calculation is:
Break-even point = 32,400 / 2.50 − 0.50 = 16,200
Assuming she operates 16 days per month, on average, over 12 months that’s 192 days. She would need to sell an average of 85 servings per day.
With this information, the entrepreneur can now assess her business idea based on industry-standard figures.
Final thoughts: Calculate profitability and assess risks
Using the break-even point, you can determine at what sales volume a product starts to generate profit. This will help you evaluate whether a business idea is economically viable and whether it’s worth taking an investment risk. The basic formula uses fixed and variable costs and the selling price. Step-fixed costs, scale effects and a broad product range make the calculation more complex.
With the break-even point, you can strategically plan and forecast the financial health of your business or new ventures. It serves as a vital tool in financial planning, helping to ensure that investments are sound and aligned with business goals. Regular review and adjustment based on changes in the market or business model are essential to maintain accuracy and relevance.
By effectively utilizing the break-even analysis, companies can make informed decisions that enhance their operational efficiency and profitability. Whether adjusting pricing strategies, optimizing cost structures, or exploring new markets, the insights gained from break-even calculations are indispensable for sustained business success.
This strategic approach not only secures financial stability but also supports dynamic business growth, ensuring that companies can adapt to changing market conditions and seize opportunities as they arise.
