Break-Even Analysis Guide: How to Calculate BEP and Apply It to Your Business

Knowing your break even point (BEP) is an essential part of running a small business and will help you determine the health of your business. The break even point is the amount a company needs to produce to match its costs. Put another way, it’s the point beyond which you start to make a profit.

The break even point is calculated by dividing the fixed costs by the contribution margin. The contribution margin is the selling price per unit minus the variable costs per unit and represents the amount of revenue left over once all variable costs to generate that revenue have been met.

Knowing what that amount is will help you determine fixed costs (like rent) and variable costs (like materials) so you can set your prices appropriately and forecast when your business will reach profitability.

What is the break-even point for a business?

A business’s break-even point is the stage at which its revenue equalises with its costs. Once you determine that figure, you can take a hard look at all your costs — from rent and labour, to materials — as well as your pricing structure.

You can then then ask yourself these questions:

• Are my prices too low or my costs too high to reach break-even point in a reasonable amount of time?
• When can I expect to break even?
• Is my business sustainable as a result?

Calculating your break-even point

There are two basic formulas for determining a business’s break-even point. One is based on the number of units of products sold. The other is based on points on sales in GBP.

• To calculate break-even point based on units: Divide fixed costs by the revenue per unit minus the variable cost per unit. The fixed costs are those that do not change regardless of units are sold. The revenue is the price for which you’re selling the product minus the variable costs, like labour and materials.

  Break-Even Point (units) = Fixed Costs ÷ (Revenue Per Unit – Variable Cost Per Unit)

• To calculate break-even point based on sales in GBP: Divide your fixed costs by the contribution margin. The contribution margin is calculated by subtracting variable costs from the price of a product. This amount is then used to cover the fixed costs.

  Break-Even Point (Sales in GBP) = Fixed Costs ÷ Contribution Margin

  Contribution Margin = Price of Product – Variable Costs

To better explain what all of this means, let’s look at a break down of the formula components:

• Fixed costs. Fixed costs are not affected by the number of items sold. Examples include rent paid for storefronts or production facilities, computers and software. Fixed costs also include fees paid for services like graphic design, advertising and PR.
• Variable costs. Variable costs are those that vary with output, such as wages, utilities and materials used in production.
• Contribution margin. The contribution margin is calculated by subtracting an item’s variable costs from the selling price. So if you’re selling a product for £100 and the cost of materials and labour is £40, the contribution margin is £60. This £60 is then used to cover the fixed costs. Any money left after that represents your net profit.
• Contribution margin ratio. This figure is usually expressed as a percentage. It’s calculated by subtracting your fixed costs from your contribution margin. From there, you can determine what you need to do to break even, like cutting production costs or raising your prices.
• Profit earned following your break even. Once your sales amount equals your fixed and variable costs, you have reached the break-even point. The company will report a net profit or loss of £0, and any sales beyond that point contribute to your net profit.

How to use a break-even analysis

A break-even analysis enables you to determine your break-even point. But this isn’t the end of your calculations.

After crunching the numbers, you need to ask yourself whether your current plan is realistic or if you need to raise prices, cut costs or both. You should also consider whether your products will be successful in the market. Although the break-even analysis determines the number of products you need to sell, there’s no guarantee you’ll hit that number.

You should ideally conduct this analysis before you start a business so you have a good idea of the risk involved. But if you’re an existing business, conduct this analysis before launching a new product or service to determine whether or not the potential profit is worth the startup cost.

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.

• Prices. If the analysis shows that your current product costs are too low for you to break even in your desired timeframe, you might want to raise them. Check the cost of comparable items before you do so to ensure you don’t price yourself out of the market.
• Materials. Is the cost of materials and labour unsustainable? Research how you can maintain a high level of quality whilst lowering your costs.
• New products. Before you launch a new product, take into account both the new variable costs as well as the fixed costs.
• 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.
• Goals. 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.

Every small business owner dreams of break-even point and what comes beyond. The good news is that you don’t have to wait around and speculate. Using a break-even analysis, you can project when and how you’ll reach break-even point. This in turn will enable you to stop dreaming and start taking measures to make sure you get there.

FAQs about break even point

What factors affect a company’s break even point?

Several things can mean a break even point will vary such as an increase in a company’s fixed expenses, an increase in variable costs, a decrease in selling prices and an unfavourable change in the number of products sold.

What are the limitations of break even point?

BEP assumes a business will sell all its stock at the same price and variable costs can change regularly which could render an analysis inaccurate. Additionally, businesses could have unrealistic calculations around the number of products sold and costs.

Can a break even point be negative?

In theory, yes. It indicates a company’s operating expenses are higher than sales income which leads to a net loss. In practice, it’s unsustainable because a business could not continue to operate indefinitely at a loss. It often occurs when a company has high fixed costs such as rent but experiences low sales income.

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