What is Break-Even Point?
The Break-Even Point (BEP) is the inflection point at which the revenue output of a company is equal to its total costs and starts to generate a profit.
How to Calculate Break-Even Point?
There is no net loss or gain at the break-even point (BEP), but the company is now operating at a profit from that point onward.
For all business owners, particularly during the earlier stages of a business, one of the most crucial questions to answer is: “When will my business break even?”
Businesses share the similar core objective of eventually becoming profitable in order to continue operating. Otherwise, the business will need to wind-down since the current business model is not sustainable.
By understanding the required output to break even, a company can set revenue targets accordingly, as well as adjust its business strategy such as the pricing of its products/services and how it chooses to allocate its capital.
If a company has reached its break-even point, this means the company is operating at neither a net loss nor a net gain (i.e. “broken even”).
The incremental revenue beyond the break-even point (BEP) contributes toward the accumulation of more profits for the company.
Conducting a break-even analysis is a prerequisite to setting prices appropriately, establishing clear and logical sales target goals, and identifying weaknesses in the current state of the business model that could benefit from improvements (e.g., sales tactics and marketing strategies).
Furthermore, established companies with a diverse portfolio of product/service offerings can estimate the break-even point on an individualized product-level basis to assess whether adding a certain product would be economically viable. In effect, the analysis enables setting more concrete sales goals as you have a specific number to target in mind.
Break-Even Point Formula (BEP)
To take a step back, the contribution margin is the selling price per unit minus the variable costs per unit, and represents the amount of revenue remaining after meeting all the associated variable costs accumulated to generate that revenue.
- Contribution Margin = Fixed Costs→ That said, when a company’s contribution margin (in dollar terms) is equal to its fixed costs, the company is at its break-even point.
- Contribution Margin > Fixed Costs→ If the company’s contribution margin exceeds its fixed costs, then the company actually starts profiting from the sale of its products or services.
Quick Break Even Analysis Example (BEP)
For example, if a company has $10,000 in fixed costs per month, and their product has an average selling price (ASP) of $100, and the variable cost is $20 for each product, that comes out to a contribution margin per unit of $80.
- Fixed Costs per Month = $10,000
- Average Selling Price (ASP) = $100.00
- Variable Cost per Unit = $20.00
- Contribution Margin = $80.00
Then, by dividing $10k in fixed costs by the $80 contribution margin, you’ll end up with 125 units as the break-even point, meaning that if the company sells 125 units of its product, it’ll have made $0 in net profit.
- Break-Even Point (BEP) = 125 Units
Or, if using Excel, the break-even point can be calculated using the “Goal Seek” function.
After entering the end result being solved for (i.e., the net profit of zero), the tool determines the value of the variable (i.e., the number of units that must be sold) that makes the equation true.
Break-Even Point Calculator (BEP)
We’ll now move to a modeling exercise, which you can access by filling out the form below.
1. Unit Economics and Cost Structure Assumptions
Let’s say that we have a company that sells products priced at $20.00 per unit, so revenue will be equal to the number of units sold multiplied by the $20.00 price tag.
- Selling Price Per Unit = $20.00
In terms of its cost structure, the company has fixed costs (i.e., constant regardless of production volume) that amounts to $50k per year. Recall, fixed costs are independent of the sales volume for the given period, and include costs such as the monthly rent, the base employee salaries, and insurance.
- Total Fixed Costs = $50,000
Moving onto our final assumption, the variable costs directly associated with the production of the products being sold are $10.00.
- Variable Costs = $10.00 Per Unit
In contrast to fixed costs, variable costs increase (or decrease) based on the number of units sold. If customer demand and sales are higher for the company in a certain period, its variable costs will also move in the same direction and increase (and vice versa).
The total variable costs will therefore be equal to the variable cost per unit of $10.00 multiplied by the number of units sold.
2. Excel Goal Seek Function
We now have the assumptions in place to use the “Goal Seek” function in Excel (Alt ➝ A ➝ W ➝ G).
- Step 1 → First, we link to the net profit cell for the “Set cell” selection
- Step 2 → In the subsequent step, we are going to input zero as the “To value” since the profit we are targeting is $0 (i.e., the break-even point)
- Step 3 → Lastly, the “By changing cell” will be set to the number of units sold, as this is the variable that Excel will be adjusting until our target profit value is met
Upon doing so, the number of units sold cell changes to 5,000, and our net profit is equal to zero, as shown below in the screenshot of the finished solution.
3. Break-Even Point Analysis Example
Quantifying the required number of units to be sold to have a net profit of zero was our intended goal, which in this particular scenario, the company must sell 5k units of its products to break even and start to generate a profit from its operations.
As we can see from the sensitivity table, the company operates at a loss until it begins to sell products in quantities in excess of 5k. For instance, if the company sells 5.5k products, its net profit is $5k.
Alternatively, the break-even point can also be calculated by dividing the fixed costs by the contribution margin.
The total fixed costs are $50k, and the contribution margin ($) is the difference between the selling price per unit and the variable cost per unit. So, after deducting $10.00 from $20.00, the contribution margin comes out to $10.00.
- Contribution Margin = $20.00 – $10.00 = $10.00
In conclusion, just like the output for the goal seek approach in Excel, the implied units needed to be sold for the company to break even come out to 5k.
- Break-Even Point = 5,000 Units Sold