How to calculate and interpret the break even point in your company
The break-even point is an important key figure in the cost-benefit calculation of a company. It provides information about the sales volume from which a company makes a profit with the sale of a product. We explain in this article with the help of formulas and an example how to calculate the break-even point and how the break-even point analysis helps companies.
Break Even Point: Definition
The break-even point indicates the point at which the costs (e.g. for the production of a product) are equal to the revenue generated by the sale. This means that the break even point is exactly £0 in total. From the point at which the break-even point is exceeded, the company makes a profit through the sale.
Break Even Point Graph
The break-even point can be determined both graphically and mathematically. To determine the break-even point graphically, the total cost curve of a product over time is plotted in a diagram.
On the x-axis (horizontal axis) you plot the sales volume (how many products are sold) and on the y-axis (vertical axis) you plot the total cost of producing a given quantity of product.
The same diagram is then used to draw the revenues that are achieved through the sale of a certain sales volume. The break-even point is the point where the two curves intersect.
Break Even Point: Formula
There are two ways to calculate the break-even point.
Break Even Point in units: formula
Break Even Point (unit) = Fixed costs / (Revenue per unit - variable costs per unit)
The fixed costs are independent of the number of units sold, while the variable unit costs are dependent on this. The turnover per unit is the selling price of the product. The break-even point thus indicates how many units must be sold in order to cover the costs.
Break Even Point formula in sales
The above formula can also be expressed using the contribution margin:
Break Even Point (sales) = Fixed costs / contribution margin
The contribution margin is obtained with the following formula:
Contribution margin = product price - variable costs
The contribution margin is the amount with which the fixed costs are covered.
Break Even Point: Example
Let's look at the above formulas with an example: To manufacture a product, a company incurs the following costs:
- Fixed costs per month: £1,000
- Variable costs per unit: £0.5
- Selling price per unit: £2
We now calculate the break-even point in units:
Break Even Point (unit) = £1,000 / (£2 - £0.5) = 666.67 units
The company must therefore sell at least 667 units per month to cover the fixed costs.
If we know the contribution margin (£2 - £0.5 = £1.5) we can also calculate the break even point using this:
Break Even Point (sales) = £1,000 / £1.5 = 666.67
Break Even Point Analysis
Break-even point analysis is used to evaluate the efficiency of a product or service. It can be applied to a single product as well as to a complete product range. With such an analysis, companies estimate how many products or services they need to sell until they can fully cover the costs with the proceeds.
Using the formulas and example above, we have seen how the break-even point can be used for corporate strategy purposes. In the context of the break-even point analysis, companies assess whether the costs of a product justify the benefits (profit).
If the analysis shows, for example, that a large number of products must be sold in order to reach the break-even point, a product idea can be eliminated in advance. If it is unrealistic that the necessary sales volume can be achieved within a certain period of time, the product does not even need to be manufactured, or one should then think about adapting the product in order to increase the sales volume or reduce the costs.
On the other hand, you can also see when a product has a very high efficiency. This is the case when the break-even point is reached with a low sales volume.
Break Even Point in Accounting to help find the best product price
The break-even point analysis can also help with pricing. For example, if you have an idea of the minimum number of products you want to sell within a certain period of time in order to reach the break-even point, you can calculate how high you have to set the unit price for the product.
If this is too high and cannot keep up with competing products, the ideas about sales volume are unrealistic and the product concept and/or pricing strategy must be adjusted.
If you have several product ideas, the break-even point analysis helps you to assess with which product you will achieve a profit the fastest. The break-even point is calculated for each product by inserting the costs and the product prices into the break-even point formula. You then get a sales volume for each product. The one with the smallest value then leads the fastest to the break-even point and thus to profit.
