What is the Break-Even Point?
The Break-Even Point refers to the necessary level of output for a company’s revenue to be equal to its total costs. Said differently, the break-even point is the inflection point at which a company begins to generate a profit.
- What is the purpose of conducting a break-even analysis?
- How can the “Goal Seek” function in Excel be used to calculate the break-even point?
- Which formula could you use to calculate the break-even point?
- What are some of the types of insights that can be derived from conducting break-even analysis?
Break-Even Point Concept
For all businesses owners, particularly during the earlier stages of a business, one of the most crucial questions to answer is: “When will my business break-even?”
All businesses share the similar goal of eventually becoming profitable in order to continue operating. An unprofitable business eventually runs out of cash on hand, and its operations can no longer be sustained (e.g., compensate employees, purchase inventory, office rent).
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”).
All incremental revenue beyond this point 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, marketing strategy).
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, this enables setting more concrete sales goals as you have a specific number to target in mind.
Break-Even Point Formula
The formula for calculating the break-even point involves taking the total fixed costs and dividing the amount by the contribution margin per unit.
To take a step back, the contribution margin is the selling price per unit minus the variable costs per unit, and this metric represents the amount of revenue remaining after meeting all of the associated variable costs accumulated to generate that revenue.
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. If its contribution margin exceeds its fixed costs, then the company actually starts profiting from the sale of its products/services.
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.
Then, by dividing $10k in fixed costs by the $80 contribution margin, you’ll end up with 125 units as the break-even point. This means that if the company sells 125 units of its product, it’ll have made $0 in net profit.
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.
Excel Template Download
Now, we’ll go through an example calculation of the break-even point using the goal seek approach, as well as the manual calculation. To get started, fill out the form below to download the spreadsheet and follow along.
Break-Even Point Example Calculation
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.
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.
Moving onto our final assumption, the variable costs directly associated with the production of the products being sold are $10.00.
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.
We now have the assumptions in place to use the “Goal Seek” function in Excel (Alt ➝ A ➝ W ➝ G).
- First, we link to the net profit cell for the “Set cell” selection
- 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)
- 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.
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 variable cost per unit.
So, after deducting $10.00 from $20.00, the contribution margin comes out to $10.00. And just like the output for the goal seek approach in Excel, the implied units needed to be sold for the company to break even comes out to 5k.