A break-even point (BEP) — in accounting and finance — is the term defining the stage of business development when the revenue you make equals the costs. Putting it another way, it is a point when you already aren’t making losses but aren’t getting profit yet and an accounting services company can always help you to figure out when this moment happens.
What is the break-even point for?
- To find out how much you must sell (and at what price) to make a profit.
- To estimate the maximum profit on a particular product/service that you can generate (as once the break-even point is reached, the scale will help you determine what unused capacities you still have).
- To make sales forecasts (to know how to reach the break-even point before running out of funds and to find out whether your business idea is viable).
- To develop sales targets and pricing strategy.
- To estimate how efficient it will be to introduce a new product (especially if it requires significant spendings).
- To work out the new selling prices, if you, for example, plan to switch from wholesale business to retailing. Or just want to know what changes in profits you will have if you change the price of the product.
- To find out the amount of losses that you can have in case of a fall in sales.
Break-even point formula
The formula helps to learn how many products you need to sell in a certain period of time for your company to break even. In other words, it gives you a quantity, not an index, and shows exactly how many pairs of gloves you need to sell at your current price not to lose or make money.
BEP = Fixed costs/ (Price – Variable costs).
As you can see, the break-even formula involves both fixed and variable costs of your company as well as the price you set for your product.
Fixed costs are those that remain the same regardless of the sales volume — so they remain fixed over a period of time. For example, you will pay the same salaries and rent no matter how much or how little you sell. Fixed costs also include mortgage, utilities (electricity, telephone services, etc.), insurance, loans, and depreciation of equipment (of office computers, for example).
Price means the selling price of 1 product/service.
Variable costs are the costs which depend on the sales volume. They include:
- materials (the more teddy bears you make to sell, the more fabric you need)
- wages (if you reward your promoter for sales)
- marketing (you spend money on bringing in more customers, which might lead to bigger sales).
In the formula, the variable costs per unit are subtracted from the cost of one unit to calculate how much you make on the sale of one unit.
So what you do is basically divide the fixed costs by the revenue per product. Easy-peasy!
Break-even point calculation example
James has a dry cleaning business “Busy Cleaning” and wants to know how many items he needs to sell (in this case, how much cleaning service to render) in order to break even weekly.
We know that we need 3 things to calculate the break-even point: the Fixed costs, the Price per unit, and the Variable costs per unit.
“Busy Cleaning” has £1,000 of fixed costs a week: James pays £250 on renting the cleaning space, £700 in salaries and £50 for the insurance.
“Busy Cleaning” offers a fixed price of £20 for a standard cleaning of a piece of clothing, which includes washing, drying and ironing. The company’s variable costs per piece of clothing are £7.50. This includes paying £5 for cleaning materials, £2,50 for water and electricity.
Applying the break-even formula: £1,000/(£20 – £7.50)=80.
80 is the number of pieces of clothing “Busy Cleaning” needs to clean a week to reach the break-even point for this period of time.
Break-even point analysis
Despite the break-even point being a useful tool to know how to generate a bigger profit, it also helps to find out the overall ability of a business to get it.
If the company’s break-even point is close to the maximum sales level, it is nearly impossible to generate profit. So it is necessary to reduce the break-even point — in other words, the business needs to find a way either to reduce the fixed costs or to make more money on one sale (raise the price or reduce the variable costs).
But from theory to practice: Jason makes shoes. Over a month, his fixed costs are £1,000, and his variable costs per pair are £40 while the shoes price is £45. The guy needs to sell 200 pairs of shoes every month to just stop losing money! But he can’t even make that many! So what can Jason do to influence the break-even point? Well, he could start placing more ads on Facebook. But in this case, his variable costs would grow and so would the break-even point figure. He could try to cut the fixed costs — but he needs the studio, and the rent is already rather cheap for London. So it makes sense for Jason to raise the prices. In the end, he produces hand-made shoes in the UK, right?
In fact, there are more options to make your break-even point more achievable. You can:
- eliminate of any of either fixed/variable costs
- push sales of the highest-margin units
- outsource any of the fixed costs
- reduce price deductions (such as coupons and sales)
The list is non-exhaustive, but it will give you the idea.