So, you’ve started a business and everything is up and running. You’re selling your product or service to customers and you’re seeing an increase in sales and satisfaction. But, there’s a problem. Your books tell you that you’re not making a profit. So what’s it going to take to make a profit? That’s where understanding how to calculate your break-even point becomes handy.
The break-even point? Huh?
In its simplest sense, the break-even point can be defined as the moment a business isn’t losing money or making a profit, but breaks completely even at $0. All the money coming in from sales will be equal to the money going out for costs. The break-even point will be equal to the number of units a business must sell to reach this $0 point.
Let’s dive a little deeper.
First, let’s look at the break-even equation:
Break-Even Point (in units) = Fixed Costs / Gross Profit (per unit)
The equation takes fixed costs and divides them by gross profit. The fixed costs (sometimes referred to as operating costs) can be any recurring expense that you have to pay to keep your business up and running. These costs have to be paid, even if no sales are made. Some common operating costs include rent, insurance and internet, to name just a few.
Gross profit is broken down into the item or service sales price minus variable costs. The variable costs are determined to be the amount of money it takes to produce one unit of your offering. In some cases, the offering may have multiple variable costs. For example, if you sell brownies, your variable costs would include the sugar, eggs, cocoa, etc. needed to go in the brownies. All of the variable costs to create a product can be added up and known as the cost of goods sold, or as us accountants lovingly refer to it: COGS.
So, taking this information, we can conclude that gross profit is the amount of money you make on each sale after subtracting COGS from your sales price. The broken down equation is as follows:
Break-Even Point = Fixed Costs (aka Operating Costs) / (Sales price – Variable Costs (a.k.a COGS))
Putting it all together
So, how do you put all this information together to find your break-even point? Let’s look at an example. Let’s say you are in the business of selling widgets. Your operating expenses, which include rent, internet and insurance, total $10,000. The COGS for each widget is $20, and you sell each widget for $40, leaving you with a gross profit of $20. We can put these numbers into the break-even equation to find how many widgets you must sell to break even.
Break-Even Point = $10,000 / ($40 – $20)
Break-Even Point = $10,000 / $20
So, to break-even, you would need to sell 500 widgets.
Take it one step further
Not only can the break-even point be used to calculate point zero, you can also use the calculation to determine what it’s going to take to get to your desired profit. Building on the previous example, let’s say you want to make $10,000 (meaning when all the numbers are in, you want the bottom line (aka net income) to be $10,000 not $0). You can simply add the $10,000 to your fixed costs.
Break-Even Point = ($10,000 + $10,000) / ($40 – $20)
Break-Even Point = $20,000 / $20
So, to break-even, you would need to sell 1,000 widgets.
Wrapping it up
The example provided above is simple, yet provides a good explanation of the break-even point and how to reach it. Of course, every business will incur different types of costs and expenses which will need to be taken into account when calculating this amount. If all this seems a bit confusing, our Accounting Coach 1.0 service can help you navigate through the waters.