How the Break-Even Formula Can Make or Break Your Company
“When can my company finally break even?” This is a dilemma that you must figure out when opening up a new business. That’s why learning about the break-even formula, and how to apply it, is so important.
It will assist you in figuring out the precise numbers for not only fixed cost, but variable costs as well. Doing this is key for business owners to set reasonable prices. It also allows them to forecast when their company will be profitable.
To use the break-even formula, you have to understand the BEP. What does that stand for? It’s a company’s break-even point
What’s a Break-Even Point?
It occurs when a company’s revenue is equal to the costs. Once that figure’s determined, an owner must examine all costs. These include labor, materials, rent, and pricing structure.
Next, always ask yourself the following three questions. These are for figuring out if you can achieve the break-event point any time soon:
-Are the company’s prices not high enough?
-Are the company’s costs too expensive?
-Is my company’s business model sustainable?
Calculating the BEP
When it comes to determining a company’s break-even point, there are two formulas that you should know. The first involves the total units purchased. The other? Sales revenue.
How to Calculate the Break-Even Point According to Units Sold
The first step is to divide your fixed costs by the profit number for each unit. Next, subtract the cost for each unit.
Fixed costs? They’re costs that never change, despite the number of units that get sold.
In this case, what is revenue? It’s the price of the product you’re selling. But you first must subtract variables costs, such as materials and labor.
Here’s how the calculation should look:
Break-Even Point equals Fixed Costs divided by (Revenue per Unit – Variable Cost.
This is for each unit.
How to Calculate the Break-Even Point of Your Company’s Sales Revenue
The first step is to divide your fixed costs by the margin of contribution. What’s the margin of contribution? It’s the total you get by subtracting variable costs from the product’s price. You can then use the amount to take care of your fixed total costs.
Here’s how the calculation should look:
Contribution Margin = Price of Product subtracted by the Variable Costs
Break-Even Point (Revenue from Sales) = Fixed Costs divided by the Contribution Margin
Let’s examine each contributing factor when it comes to break-even formulas.
As mentioned, fixed costs stay unaffected by the number of items that get purchased. The number of purchased items includes the following. It could be the rent total for a company’s storefront. Or, factors such as: computers, software, or even production facilities. Fixed costs include include any fees a business pays for services. Some examples of services include: advertising, PR, and graphic design.
It’s very simple to calculate the contribution margin. All you need to do is subtract the variable costs of a product from the retail price.
Let’s say you’re selling shoes at $100 per pair. And let’s say the labor and material total comes out to $40. How much would the contribution margin be? … $60! Next, that money gets utilized to cover fixed costs. What is any remaining money after that classified as? It’s none other than your net profit.
-Contribution Margin Ratio:
This one is almost always a percentage. How is it determined? By taking the contribution margin and subtracting the fixed costs. Next, you can figure out what must happen so the company can break even. You must consider raising your prices. Or, you should find creative ways to cut production costs.
-Profit Earned After the Company Breaks Even:
When does a company reach the break-even point? When its sales are equal to both the variable and fixed costs. You’re going to have one of two things. A loss of zero dollars or a net profit. Sales that go beyond the break-even point are part of a business’ net profit.
What’s the Purpose of Break-Even Formulas?
Using a break-even formula to figure out the break-even point doesn’t mean you’re finished. There are still more calculations that need to take place. Often, after calculations, business owners realize that they need to sell more units. At least more than first estimated, so they can break even.
Business owners have little choice but to ask themselves if their strategy’s sustainable. Both in the short-term and long-term. An owner might realize that he or she needs to reduce costs, raise prices, or do both at once.
A business owner must also determine if the company’s products will sell, based on the current market. Sure, the break-even formula helps people figure out the total units that must get sold. But are they guaranteed to sell? Oftentimes, the answer is no.
When’s the Best Time to Use the Break-Even Formula?
It’s best to analyze the above criteria before you even open a business. This is so you can comprehend the risks you’re taking. One must determine if launching a new company will lead to success or failure.
But don’t despair if your business is already operational. You can do a break-even analysis before releasing new products or services. This will help your company figure out whether the company’s input will lead to enough output, AKA profit.
Don’t assume that applying break-even formulas is only for startups. Below are various ways that companies can use break-even analysis. It’s used for both planning and daily operations:
Your calculations may determine that the current pricing needs to be higher. This is almost guaranteed to stop you from breaking even any time soon. There’s an easy solution for this. All you need to is increase the product’s cost. You’ll first need to check out how much similar items are selling for. The last thing you want to do is go out of business thanks to poor pricing strategies.
Are you going to be unable to afford materials over the long-haul? What about the cost of labor? If so, you’ll need to be creative and find a way for your products to be well-made while cutting the costs.
It’s always a mistake to release a new item or service without adequate preparation. You’ve got to keep both the variable costs and fixed variable costs in mind.
Setting long-term goals should never be difficult—and here’s some good news. It becomes so much easier when you understand how much profit’s needed.
For example, say you you want to move your company to a larger location with more expensive rent. You need to figure out how many products must get purchased by customers. This will take care of recently adjusted fixed costs.
Here’s one of the most powerful (and free) motivation tools available for you and your staff. It’s knowing how many items customers must buy. And/or how much money the company needs to make to profit or at least not lose any money.
Below are two questions our firm often receives when it comes to break-even formulas—
“If my company’s sales numbers change, what happens to the break-even point?”
Sales numbers are always capable of changing. This is due to both internal and external factors. Let’s use an external factor as an example. Say the economy is in a recession. It’s likely that your sales numbers will decrease. If this occurs, you’re risking not being able to reach the break-even point. This means, as a business owner, you won’t be able to pay all the mandatory expenses. So, what should you do in this situation?
The break-even formula actually gives you two solutions to the problem:
1) You can figure out ways to cut both variable costs and fixed costs.
2) You can increase the price of some of your products.
If you decide to cut costs, you might be wondering—
“How will cost-cutting change my company’s break-even point?”
Say you determine that you need to cut the cost of your overhead or fixed costs. Your solution? You cut your own salary by $10,000. Doing so allows your fixed costs to decrease from $60,000 to $50,000. You would then use the break-even formula to determine the break-even point:
$50,000 divided by ($2.00 – 80 cents) = 41,666 units
As always, cutting the fixed costs reduced the total of your break-even point.
Say you reduce the variable costs by reducing the costs of products sold to 60 cents-a-unit. This means your new break-even point is this:
$60,000 divided by ($2.00 – 60 cents) = 42,857 units
In this example, the reduction in the cost of variables has allowed you to lower the breakeven point. You didn’t even have to increase any prices.
When it comes to owning a business, all numbers and variables connect with one another. Any decision you or your staff makes about pricing, costs, and sales volumes is important. It affects whether your company can survive in the long-haul. That’s why you must use the break-even formula to your advantage. Determining the break-even point is an important factor of cost-volume-profit analysis. It’s the first, crucial step toward securing a sales price-point that will bring you profit.