One of the basic measures of success is whether your company is making enough money to cover its expenses. While success can be measured in clients’ happiness and the satisfaction of your workers, being able to run your finances smoothly is important.
Your break-even point as a company is the point at which your business is making enough money to cover its operating costs and is not incurring a loss. Being able to calculate your break-even point gives you an accurate picture as to what your prices should be and where you need to cut down on expenses for good cash flow management.
According to a study referenced by the National Federation of Independent Business (NFIB), 82% of businesses fail because of poor cash flow management or a poor understanding of its concept. Incorrectly balancing your business’s books or declining to do so places your business in a potentially dangerous economic position. Understanding what your break-even point is and how to calculate it is key.
What Is the Break-Even Point?
If your revenue is below the break-even point, your business is incurring a loss. If the company’s revenue sits above the break-even point, you are making a profit.
Many industries use this calculation to ensure adequate cash flow, including those operating in manufacturing, healthcare, hospitality, and retail. Calculating your break-even point involves knowing what your fixed costs are, as well as your variable costs per unit, and your sales price per unit.
Your fixed costs often involve financial duties that typically stay stable over time and can include items like:
- A lease.
- Mortgage payments.
- Property taxes.
- Interest expenses.
Variable costs in business fluctuate or depend on external factors. This can include your money put towards paying for things like:
- Raw materials.
- Piece-rate labor.
- Staffing costs.
- Credit card fees.
Organizations that face a shortfall when it’s time to pay bills — including payroll — may turn to factoring services to stay operational until they can adjust cash flow to cover all expenses.
The last part of the equation would be the sales price per unit. It consists of the amount of money you would make by selling one unit of your product or service.
Break-Even Point Formula
The break-even point formula involves using one of two equations. You can calculate your break-even point using your sales per unit or your sales per dollar. Let’s take a look at each calculation.
To calculate your break-even point using sales per unit, divide your fixed costs by your
contribution margin per unit, or your sales per unit-variable costs per unit.
The break-even units formula is:
Break-Even Point in Units = Fixed Costs
(Sales Per Unit -Variable Cost Per Unit)
This calculation will give you the total amount of units of a product you need to sell in
order to break even.
Per Sales Dollars
To calculate your break-even point based on sales per dollar, multiply the price of
each unit by your breakeven point in units.
The break-even point in sales dollars formula is:
Break-Even Point in Dollars = Sales Price per Unit x Break-Even Point in Units
The result of this equation will provide you with the total sales you need to achieve to break-even or to have zero losses and zero profits.
Examples of Calculating Break-Even Point
There are plenty of situations in which you would need to calculate your break-even point, so let’s take a look at a typical scenario where it would be used.
Imagine you own a healthcare supply company. Your company delivers medical supplies to hospitals, doctors’ offices, and other medical establishments. To calculate your break-even point in units, you need to first determine what your fixed costs are, as well as your sales per unit and your variable costs.
- Your fixed costs may consist of the salaries you pay your employees and the rent you pay on a warehouse where medical supplies are stored before they’re sold and delivered. Let’s say these costs add up to $500,000 per month.
- Your sales per unit represents the revenue you bring by selling your medical supplies, such as boxes of disposable latex gloves. Let’s say this adds up to $500 per month.
- Your variable costs per unit would consist of the purchase of the medical supplies from the original manufacturer, and your gas bill for the office and warehouse. Let’s say these add up to $300 per month.
By using the break-even point in the units equation above, the result would equate to 2500. In this scenario, you would need to sell 2500 units of medical supplies per month to break even and cover all your costs. If you sell more than 2500 units, you would make a profit.
Using the break-even in total sales equation, you would need to sell $1,250,000 worth of medical supplies to break even. Anything sold above this is a profit and anything lower would require operating at a loss. As a result, your medical supplies business may require factoring services to make up for the shortfall and cover your expenses.
Performing a break-even point analysis is important to the ongoing economic health of your company and integral to ensuring you have adequate cash flow at all times. Take a second look at your business’ finances yourself when you’re first starting, or whenever your expenses or revenue changes. By doing this, you can determine if you need to raise your prices and/or make cuts to your expenses to both break even and remain profitable.