Central to the break-even analysis is the concept of the break-even point (BEP). As a business owner, being aware of this Key Performance Indicator (KPI) can determine your entire future.This guide will help you understand what a break-even point is, how to calculate it – and how to use it to improve business outcomes.
What is the break-even point (BEP) formula for a business?
A business’s break-even point is the stage at which revenues equal costs. Once you determine that number, you should take a hard look at all your costs — from rent to labour to materials — as well as your pricing structure.
Then ask yourself these questions: Are your prices too low or your costs too high to reach your break-even point in a reasonable amount of time? Is your business sustainable? What can you do to reduce costs or increase sales without compromising the quality of your services and products?
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How to calculate break-even point
Wondering how to calculate your break-even point? There are a two break-even point formulas for determining a business’s break point. One of them is based on the number of units of product sold and the other is based on total sales in Canadian dollars.
How to Calculate a Break-Even Point Based On Units
To calculate break-even point based on units, divide your total fixed costs by your revenue per unit minus the unit variable cost.
Your fixed costs are those that do not change regardless of the number of units sold.
Your revenue is the price for which you’re selling the product minus variable costs such as labour and materials.
Break-Even Point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)
When Determining a Break-Even Point Based On Sales Dollars
When determining a break-even point based on sales in Canadian dollars, divide your fixed costs by your contribution margin.
Your contribution margin is determined by subtracting total variable costs from the selling price of a product. This amount is used to cover fixed expenses.
Break-Even Point (sales CAD) = Fixed Costs ÷ Contribution Margin
Contribution Margin = Price of Product – Variable Costs
Breaking down the components of a break-even analysis
To get a better sense of what this information means and how it affects your business, let’s analyze the break-even point formula components in detail.
1. Fixed costs
Fixed costs are business costs that are constant. They are not affected by the number of items sold, such as rent paid for storefronts or production facilities, computers and software. Fixed costs also include fees paid for services like graphic design, advertising and public relations.
2. Contribution margin
A contribution margin (or gross margin) is the profit left after covering the costs associated with selling a product. It’s calculated by subtracting an item’s total variable costs from its selling price.
So if you’re selling a product for $100 and the cost of materials and labour is $40, then the contribution margin is $60. This $60 is then used to cover the fixed costs, and if there is any money left after that, it’s your net profit.
From there, you can determine what you need to do to break even, like reducing production costs or raising your prices.
3. Net profit
Net profit is the profit you earn following your break-even point. Once your sales equal your total fixed and variable costs, you’ve reached the break-even point, and your company will report a net profit or loss of $0. Any sales beyond that point contribute to net profit.
How to use a break-even analysis
A break -even analysis helps you determine your break-even point. But this isn’t the end of your calculations. Consider conducting a break analysis regularly to adapt your strategies effectively. Your break-even point can evolve over time based on factors like inflation and interest rates, labour shortages, technological advancements that reduce production costs – and more.
Once you calculate the numbers, you might find that you need to sell more products than anticipated to break even.
At this stage, ask yourself whether your current financial plan is realistic, or if you need to increase prices, reduce costs, or both. Also, consider whether your products will succeed in the market. Just because the break-even analysis determines the number of products you need to sell, there’s no guarantee that they will sell.
Ideally, you should conduct this analysis before you start a business so you have a good idea of the risk involved. In other words, you should figure out if the business is worth it. Existing businesses should conduct this analysis before launching a new product or service to determine whether or not the potential profit is worth the startup costs.
A break-even analysis isn’t just useful for startup planning. Here are some ways that businesses can use it in their daily operations and planning.
1. Setting prices
If your analysis shows that your current price is too low to enable you to break even in your desired timeframe, then you might want to raise the item’s cost. Make sure to check the cost of comparable items, though, so you don’t price yourself out of the market.
2. Reducing costs
Are the cost of materials and labour unsustainable for your business? Research how you can maintain your desired level of quality while lowering your costs.
3. Launching new products
Before you launch a new product, take into account both the new variable costs as well as the fixed ones, like design and promotion fees. This step helps mitigate losses by ensuring you know the break-even point for the units required.
4. Financial planning
When you know exactly how much you need to make, it’s easier to set longer-term goals. For example, if you want to expand your business and move into a larger space with higher rent, you can determine how much more you need to sell to cover new fixed costs.
5. Goal-setting
If you know how many units you need to sell or how much money you need to make to break even, it can serve as a powerful motivational tool for you and your team.
Accessing better insights with Square
Square Analytics can help you make informed business decisions by providing you with real-time sales data and in-depth insights about profitability. Having access to numbers like item sales and different types of costs makes it easier to calculate your break-even point and improve your business. Get started with Square Point of Sale today.