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.
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How to Calculate Break-Even Point (BEP)
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.
An unprofitable business eventually runs out of cash on hand, and its operations can no longer be sustained (e.g., compensating employees, purchasing inventory, paying office rent on time).
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.
The steps to calculate the break-even point are as follows:
- Step 1 ➝ Calculate Sum of Fixed Costs
- Step 2 ➝ Calculate Contribution Margin
- Step 3 ➝ Divide Fixed Costs by Contribution Margin
Break-Even Point Formula
The formula for calculating the break-even point (BEP) involves taking the total fixed costs and dividing the amount by the contribution margin per unit.
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 ➝ If 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.
How to Conduct Break-Even Analysis
If a company has reached its break-even point, 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 insights derived from performing break-even analysis enables a company’s management team to set more concrete sales goals since a specific number to target was determined.
