“When will we actually make money?” is the burning question for new businesses. Fortunately, you can answer this question by calculating your break-even point.
What is the break-even point?
The break-even point (BEP) is the amount of product or service sales a business needs to make to begin earning more than you spend. You measure the break-even point in units of product or sales of services.
You can use the break-even point to find the number of sales you need to make to completely cover your expenses and start making profit. If you sell more than your break-even point, you’re making a profit. But if you sell less, your sales revenue won’t cover your expenses and you’ll operate at a loss.
How to calculate the break-even point
The break-even point is calculated using three values.
Your fixed costs (or fixed expenses) are the expenses that don’t change with your sales volume. Some common fixed costs are your rent payments, insurance payments and money spent on equipment. These costs will stay the same regardless of whether you sell one unit or a million units.
Your variable costs (or variable expenses) are the expenses that do change with your sales volume. This is the price of raw materials, labor, and distribution for the goods or service you sell. For a coffee shop, the variable costs would be the beans, cups, sleeves, and labor used to produce one cup of coffee.
Your sales price is just the price that you sell your product or service for.
Break-even point formula
The break-even point formula is:
Break-even point = Total fixed costs / (Sales Price Per Unit - Variable costs per unit)
Sales price per unit minus the variable costs per unit is also known as the contribution margin.
You can find your fixed costs and variable costs using your income statement.
For your fixed costs, simply add up your monthly recurring costs (like rent, web hosting, and salaries).
To find your variable costs per unit, start by finding your total cost of goods sold in a month. If you have any other costs tied to the products you sell—like payments to a contractor to complete a job—add them to your cost of goods sold to find your total variable costs. Then divide that number by the units you’ve sold that month.
Break-even point example
Maggie’s Mugs sells artisanal mugs out of a brick and mortar store. The selling price of her mugs is $20. Maggie pays artists to paint mugs for $10 a piece. Maggie buys mugs for $5 a piece. This makes her variable costs $15 a mug.
Maggie also pays $800 a month on rent, $200 in utilities, and collects a monthly salary of $1,500. This makes her fixed costs $2,500 a month.
With her shop opening next month, Maggie wants to know how many mugs she needs to sell in order to be profitable. Let’s put her price and costs into the break-even point formula:
Break-even point = Total fixed costs / (Selling Price Per Unit - Variable costs per unit)
Break-even point = $2,500 / ($20 - $15)
Break-even point = $2,500 / 5 = 500 units
Now Maggie knows she needs to sell 500 mugs to break even. If she sells more than that, she will have a profitable month.
Decisions you can make from break-even analysis
If you’re having trouble hitting your break-even point or it seems unreachable, it’s time to make a change.
There are three components to calculating your break-even point. By looking at each component individually, you can start to ask yourself critical questions about your pricing and costs.
Here are three questions you can start with.
Is your sales price right?
As you increase your sales price, your break-even point decreases. If your sales price is too low, you might have to sell too many units to break even. And as much as we think a lower price means more buyers, studies actually show that consumers rely on price to determine the quality of a product or service.
If your price is too high, you might be falling short of your break-even point because customers won’t buy at that price. Lowering your selling price will increase the sales needed to break even. But this can be offset by the increased volume of purchases from new customers.
Are your fixed costs too high?
Having high fixed costs puts a lot of pressure on a business to make up those expenses with sales revenue. If you find yourself falling short of your break-even point month over month and feel like you can’t change your prices, lowering your fixed costs can be a solution.
Here are some common ways to reduce your fixed costs:
Relocate to an area with cheaper rent or property taxes
Negotiate lower lease payments with your landlord
Sub-lease a portion of your space
Look for lower cost insurance plans
Refinance and reduce debt to reduce your interest costs
For more cost cutting ideas, check out our guide of 25 ways to cut costs.
Is my cost per unit sustainable?
The higher the variable costs, the greater the total sales needed to break even.
For the example of Maggie’s Mugs, she paid $5 per mug and $10 for them to be painted. If she keeps falling short of the 500 units needed to break even, she could potentially find a cheaper mug supplier or painters who are willing to take a lesser payment. By reducing her variable costs, Maggie would reduce the break-even point and she wouldn’t need to sell so many units to break even.
Here are some common ways to reduce your variable costs:
Spend less on raw materials: Try finding vendors with lower prices or discounts for buying in bulk. If your order will be too small for bulk discounts, look for other businesses you can form a buying group with.
Spend less on labor: Consider switching to contractors that you pay per job or per unit—that way you can guarantee the variable costs
Reduce your cost of distribution: Make sure you’re using the cheapest shipping option and the cheapest packaging.