The break even point formula is a calculation performed by businesses to discover their break even point. In other words, it shows decision-makers exactly how much revenue they need in order to balance costs. It’s a vital aspect of business planning and can inform leaders whether a business proposition is viable. It also enables businesses to see where they need to make changes.
Let’s take a look at how to calculate a break even point and why it’s important to utilize the break even formula.
The break even point in business is an accounting term. This figure determines how much revenue an organization has to generate in order to cover its total costs. When this point is reached, a business has a $0 net gain and a $0 net loss. To put it simply, when a business breaks even, it has reached the precise point where total revenue covers total costs.
For the break even analysis formula, total costs include both fixed and variable costs.
To calculate this figure, use the following break even equation.
Break Even Point in Units = Fixed Costs / (Price – Variable Costs)
In simple terms, you’re taking the unit price and subtracting variable costs. Fixed costs are then divided by that figure. Accountants may also talk about the contribution margin. Price minus variable costs equal the contribution margin. The contribution margin is what pays the fixed costs of the business.
Here are a few terms to be familiar with:
How can these factors be used in a business sense?
The formula may highlight a need to reduce variable costs. It could mean switching suppliers or reducing the company’s workforce. Alternatively, it may indicate a problem with your pricing strategies.
When applied correctly, finding the point where you break even on a product offers an insight into whether changes need to be made.
Figuring out how to find the break even point in practice can be complex. Here’s an example of how a break even point calculator would work out the final figures.
Take Note: Due to the presence of the figures for “sales price per unit,” this calculation must be done for each separate product.
Warrington Screws has decided to include rent costs, asset depreciation, salaries, and property taxes as part of its fixed costs. These fixed costs are $60,000. Their primary product is sold at $5.00 per box. Variable costs have been pegged at $0.80 per unit.
According to the break even point formula, here’s the calculation:
$60,000 / ($5.00 - $0.80) = 14,285
This means that Warrington Screws needs to sell 14,285 boxes of $5.00 screws to cover its fixed and variable costs. If 14,285 boxes were sold, the company would report its net profit/loss as $0.
Every business must be aware of the point where they expect to break even. Businesses can be making millions of dollars every year yet still lose money because they don’t break even. Knowing how much money you need to generate to break even will inform the direction of your business.
With this one figure, you can do the following:
It’s also possible to calculate for different scenarios. What if the cost of raw materials increases by 10%? What if sales fall due to an economic recession? Is your pricing strategy yielding enough profit? These are all questions you can answer by performing this calculation.
Let’s look at another example using the same figures we used for Warrington Screws. The price of the raw materials used to manufacture screws has increased. Instead of variable costs per unit being $0.80, it’s now $0.95. If we perform the same calculation, we get this:
$60,000 / ($5.00 - $0.95) = 14,814
That means to break even under these new market conditions, Warrington Screws must sell an additional 529 boxes of screws. The company could respond to this by increasing its prices or reducing its variable costs elsewhere.
The company decides to increase the cost of a box of screws to $5.25. The formula now looks like this:
$60,000 / ($5.25 - $0.95) = 13,953
Now the company only needs to sell 13,953 boxes of screws to reach break even.
The break even point formula provides valuable insights for your business. Leaders need to be able to make informed decisions and pivot when market conditions change. This formula plays a major part in the ability to accomplish that.
Contact one of the best accounting firms in Chicago— Porte Brown. Our accountants and advisors can help guide your business and teach you more about turning a profit today.
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