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Entrepreneurs or business owners majorly focus on one thing – business profit. But often find it difficult to know whether they are making a profit or suffering a loss. And that’s where businesses fall short of achieving financial goals. The reason could be having less knowledge about a break-even point or incorrect calculation. Sometimes you would be doing profitable business, but fail to realize it when you don’t have an exact formula for calculation.
The break-even point is the solution to your problem. It helps you check if the total spending costs are equal to the revenue or not, making it easier to determine business profit. So, whenever you want to find if revenue output is more or less than total costs, just calculate the break-even point. To assist you in learning how to calculate break-even point is on us in this comprehensive guide. Let us begin with what is the break-even point?
What is the Break-Even Point?
The break-even point is the process of identifying whether the company revenue output is equal to total expenses. It is considered as a point from which a company actually starts making a profit. It signifies that you have reached the level where production costs and revenues are equivalent to each other.
Most businesses do break-even point analysis to learn how soon they will make a profit and what improvements are required in the selling process. Some of them also consider changing the pricing plans in order to achieve high sales. If the break-even point analysis states you have already breached the point, then you are running a profitable business. If not, you are suffering from money loss.
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How to Calculate Your Break-even Point
To find a break-even point, you must calculate two formulas. Firstly, calculate the break-even point in units and then find the break-even point in sales dollars. For calculation, you will need the below-given details in hand.
Product price: Know the cost of the product that you have decided to charge buyers at the time of purchase.
Fixed costs: Discover the fixed costs of your business such as energy bills or office rent. It is the monthly costs, which are likely to remain the same.
Variable expenses: These costs may vary based on the production of products. It may be low or high as per materials used or other resources required.
Revenue: Get the exact figure of what you earn by selling products. Utilize this formula to determine revenue.
Revenue = Selling price X no. of units sold
Contribution margin:
Find how much you make from selling products after deducting variable expenses. A high contribution margin signifies business profitability.
The contribution margin can be known by subtracting variable costs from the price of products you sell.
How to Calculate a Break-even Point in Units
When you calculate the break-even point in units, you will figure out how many products you still need to sell in order to get a profit. Or else, whether you are already running a profitable business. For calculating a break-even point, get the fixed costs and divide by the selling price of the product minus variable expense per unit.
Here, the fixed costs are the money your business incurred regardless of sold products and variable costs are more or less charges you pay for material used in production.
Here is the break-even point formula (in units):
Fixed costs / (price per unit – Variable expense per unit) = Break-even point in units
How to Calculate a Break-even Point in Sales Dollars
When you have the break-point figured out by using the first formula, now is the time to utilize the second formula and generate a break-even point in sales dollars.
So, you need to identify the contribution margin before using this formula to evaluate BEP in sales dollars. Take the selling price of the product minus variable expenses to find the contribution margin. Below is the formula of contribution margin that you might need at this point.
Sales Price – Variable Costs = Contribution Margin
Once you know the contribution margin, apply it to the below break-even formula to identify the exact BEP in sales dollars.
Here is the formula to calculate the break-even point (in Sales Dollars):
Fixed Costs / Contribution Margin = Break-even point in Sales Dollars
Break-even analysis is not only crucial for entrepreneurs but also for those who are already running a business for a while. Let us take a look at examples to understand the break-even point in detail.
Break-even Point Examples
Let’s assume you are planning to start an eatery in California, US where you want to sell grilled cheese sandwiches. Before opening the doors, you want to know financial projections to identify if selling sandwiches can really help you make money.
At this point, use the break-even point formula to learn if your idea is worth an investment. Assuming you want to sell only grilled cheese sandwiches, here are projected business expenses and the selling price of your food item on a monthly basis.
- Fixed Costs: $1000
- Variable expenses: $2 (per unit)
- Sales price: $10 (one sandwich)
Break-Even Point in Units
Fixed Costs ÷ (Sales price – Variable expenses) = break-even point
$1000/($10 – $2) = 125 Sandwiches
So, it’s clear, you need to sell at least 125 grilled cheese sandwiches during one month to meet the break-even point.
Break-Even Point in Sales Dollars
Fixed Costs ÷ Contribution Margin (selling price – variable expense /10) = Break-Even Point in Sales Dollars
$1000/$0.8 = 1250 (BEP in Sales Dollars)
Here, the total contribution margin at the break-even point is 0.8. As a result, your company must sell sandwiches amounting to $1250 to achieve a break-even point. Once the target is achieved, your company will start earning profit.
How to Use a Break-even Analysis
So, now you know how to calculate the break-even point, but what’s next? – Make the most of those metrics in such a way that you can achieve the desired revenue for your business. Entrepreneurs can predict the revenue with the help of a break-even point formula to learn if their startup idea is worthy. The break-even analysis will help you make business decisions based on the facts.
It provides data from which you can decide where you should go ahead with a business idea or avoid taking any risk. Those who are already in business for a while can use break-even analysis to optimize pricing strategy. Plus, use it to impress potential investors as they only consider your business if there are any chances of getting a high ROI. Post-analysis you will know how much more you need to sell products. As a result, it would be much easier to improve profit margins.
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Conclusion
The break-even point, in a nutshell, is not only just a one-time process but a thing that needs to be calculated on a regular basis. Especially, if you are focusing on business growth, it needs to be monitored frequently to gauge the profitability. If needed, you can take the necessary steps to improve product sales and achieve desired cash flows.
Notably, when your business grows, you might see major ups and downs in business expenses and revenue output. Consequently, not only will the break-even point change but also it would be difficult to manage expenses unless you have invoicing software.
Invoicing software like Moon Invoice greatly tackles the hassle of performing administrative tasks. You can easily manage business expenses, invoices, and receipts no matter how big your sales figure is. The cloud-based accounting software eliminates any chance of paper misplacement by providing an online invoicing process. Get your free trial today to explore more.
