Having the ability to calculate your breakeven point is very important. After all, every unit sold afterward is profit, it’s a very important business metric. Once you know the fixed and variable costs for the product your company produces, you can then use that information to calculate your breakeven point for that specific product or service.
Small business owners can use the breakeven calculation to determine how many product units they need to sell at a specific price point to break even.
The Breakeven Point
A company’s breakeven point is the point at which it will cover all expenses related to that product by selling a unit at a specific price point. To analyze a company’s break even point in sales volume, there’s going to be 3 variables you need to know:
- Fixed Costs: Costs that are independent of sales volume, such as rent
- Variable Costs: Costs that are dependent on sales volume, such as the cost of manufacturing the product
- Selling Price: The selling price needed to break even
How to Calculate Breakeven Point
In order to calculate your company’s breakeven point, you’ll need to use the following formula:
Fixed Costs ÷ (Price – Variable Costs) = Breakeven Point in Units
Now, the breakeven point is equal to the total fixed costs divided by the difference between the unit price and variable costs. With this formula, fixed costs are stated as the total of all overhead for the company, whereas Price and Variable Costs are stated as per unit costs, which would be the price for each product unit sold.
The denominator of this equation, price minus variable costs, would be referred to as the contribution margin. After unit variable costs are subtracted from the price, the amount left (contribution margin) is available to pay the fixed costs for that business.
An Example of Finding the Breakeven Point
ABCD Company has calculated that it has fixed costs that consist of its rent, depreciation of assets and executive salaries. Those fixed costs add up to a total of $60,000. Their product is an ecommerce plugin. Their variable costs associated with producing the plugin includes raw material, labor and sales commissions. Variable costs have been calculated to be $0.80 per unit. The plugin is priced at $2.00 each.
With this information, we can calculate the breakeven point for ABCD Company’s product by using our formula above:
$60,000 ÷ ($2.00 – $0.80) = 50,000 units
What this answer means is that ABCD Company has to produce and sell 50,000 plugins in order to cover all of their expenses, fixed and variable. At this stage of sales, they would make no profit but will break even.
What Happens to the Breakeven Point If Sales Change
That’s a great question. What happens if your sales do change? For example, if the economy slows down, your sales might decline. If sales are down, you risk not selling enough to hit your breakeven point. In the example of ABCD Company, you might not sell the 50,000 units needed to break even.
In that case, you wouldn’t be able to pay all your expenses. This is a bad scenario to be in, what can you do? If you look at the breakeven formula, you can see that there’s 2 possible solutions to this problem:
- You raise your prices
- You cut fixed and variable cost
How Cutting Costs Affects the Breakeven Point
Let’s say you find a way to cut the cost of your overhead or fixed costs by negotiating a deal to cut your insurance by $10,000. In this case, your fixed costs drop from $60,000 to $50,000. Using the same formula and holding all other variables exactly as before, the breakeven point would then be:
$50,000 ÷ ($2.00-$0.80) = 41,666 units
In that case, cutting fixed costs allows you to drop our breakeven point.
If you reduce your variable costs by cutting your costs of goods sold to $0.60 per unit, holding everything else the same, you can see our breakeven point becomes:
$60,000 ÷ ($2.00-$0.60) = 42,857 units
From this analysis, you can see that if you can reduce the cost variables, you can also lower your breakeven point. In this example, we did it without raising the price.
How Fixed Costs, Variable Costs, Price, and Volume Relate
As the owner of a small business, you can see that any decision you make about pricing your product, the costs you incur in your business, and sales volume are interrelated. Calculating the breakeven point is just one component of cost-volume-profit analysis, but it’s often an essential first step in establishing a sales price-point that ensures a profit.
*Accelerated Analytics publishes resources like this to provide insights to different analytical metrics, data points and formulas. Please be aware, we’re not claiming that our POS reporting services will offer this example or any other metric, data point or formula. To learn exactly what our reporting covers, please feel free to schedule a demo or give us a call. Thanks for understanding.