When will I be able to start producing profit? 🤔 This is one of the most critical questions to ask when starting a business. That’s why it’s critical to do a break-even analysis, that will tell you how much revenue you’ll ought to pay for your fixed expenditures (such as rent) and variable expenses (such as materials) before you start generating a profit.
The break even point is achieved when a company’s revenue equals its operational expenditures. Once you have that value, you may review your pricing strategy as well as other expenditures such as rent, labor, and materials.
Break Even point formulas
Calculating a break even point formula is simple. The first is determined in terms of units sold, while the second is determined in terms of revenue. The break even point formulas are calculated as follows:
In terms of units sold:
Break-Even Point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)
In terms of revenue:
Break-Even Point (sales dollars) = Fixed Costs ÷ Contribution Margin
Contribution Margin = Price of Product – Variable Costs
Let’s examine 🧐 each component of the break even point formula in further detail to see what it all signifies.
Fixed Cost: Such type of expenses remains constant independent of sales volumes, such as office and factory rent, and supervisor salary.
Contribution margin: The contribution margin is determined by subtracting variable production costs from the selling price. If the selling price of the product is $100 and the cost of materials and labor was $40, the contribution margin would be $60.
Contribution margin ratio: Subtract your fixed expenditures from your contribution margin to get your contribution margin ratio; the resultant value is expressed as a percentage. Once you have determined your break even point, you may take actions such as reducing production costs or raising prices.
Profit: Your break even point is the point at which your revenues equal your fixed and variable costs, resulting in zero net profit or loss. After that threshold, any additional income is profit.
Easily calculate your break-even point
The easiest way to calculate your break-even point? Always have with you, on your iPhone, the ProCalc.app Business Calculator application!
Not only will the calculations be automatic, but you will see the impact of each financial change to optimize your results.
Break-Even Analysis: An important concept
Thinking about the importance of this concept! Confused? 😕 Here are some of the basic reasons;
- Decide about production units: Controls the size of production runs by establishing the number of units that must be sold for the firm or owner to break even. A product or service’s variable cost, selling price, and total cost are required for the break-even analysis.
- Budgeting and setting targets: If a firm or its owner knows its break even point, defining goals and keeping to a budget will be a lot simpler. The same kind of analysis may be done by a firm to establish a realistic objective.
- Help to manage the margin of safety: You must have a safety net even though when financial problems happened, and sales decrease. A break-even analysis is done to identify the least number of sales required to generate a profit. Using the safety margin, management may make a prudent business decision.
- Monitors and controls cost: Constant and variable costs may impair a business’s capacity to generate a profit. The break-even analysis enables managers to determine which variables increase or decrease expenditures.
- Design effective pricing strategy: Changes in product price may affect the break even point; thus, understanding this threshold may be useful when developing a pricing strategy. For instance, if the price of a product is raised, the break-even volume of sales would fall. A comparable rise in sales is necessary for a firm to break even after lowering its selling price.
Break even point formula involves comparing the total fixed expenditures to the average per-unit earnings. Using this indicator, administrators may choose a pricing strategy and assess the impact of various price points on the bottom line of the business operations. It supports business executives in making strategic decisions that provide them a competitive advantage when applied effectively.