What is your break-even point?
A business’s break-even point (sometimes known as its BEP) is the point at which its total costs are level with its total revenue.
Once your business passes its break-even point, it’s running at a profit for as long as you’re still bringing in more than you’re spending.
You might dip below your break-even point again if you make a significant investment (for example, a large order of new stock). But hopefully, the investment will pay off and you’ll pass the break-even point again.
How do you calculate your break-even point?
There are two ways of looking at your break-even point – how many units you need to sell and how much you need to take in revenue to break even.
But first, here are the figures you’ll need for the calculations:
- Fixed costs – Your business’s fixed costs are the costs which aren’t affected by the number of units you sell. For example, this could include rent or equipment and machinery costs
- Variable costs – Variable costs change depending on the amount of units you produce and sell. For example, this could include wages for your staff or the materials you use to make your products
- Sale price – This is the amount you’ll charge your customers to buy a unit.
- Contribution margin – The contribution margin is essentially the profit you make on each individual item you sell. It’s worked out by subtracting the variable cost per unit from the sale price per unit. For example, if you sell a product for £10 and it costs £4 to produce, your contribution margin for that product will be £6.
Once you know these figures, you can start working out what your BEP is.
To work out how many units you’ll have to sell to break even, you’ll need to use this calculation:
Contribution margin = (Sale price per unit – Variable cost per unit)
Break-even point (units) = Fixed costs ÷ Contribution margin
And to work out how much you’ll need to take in revenue, use the following calculation:
Break-even point (revenue) = Sale price x Break-even point (units)
Here are a few examples:
|Fixed costs||Variable cost per unit||Sale price per unit||Contribution margin per unit||BEP (units)||BEP (revenue)|
What are the limitations of break-even analysis?
There are a few limitations to break-even analysis, including:
- It assumes all units will be sold – Break-even analysis doesn’t account for pre-existing stock or wastage (units which might not sell at all)
- It doesn’t factor in external events – External factors which might affect sales or costs, like an economic downturn or a new competitor, aren’t factored in
- It assumes variable costs are static – In reality, variable costs may change in relation to input (for example, a company might be able to reduce its production costs by making a larger order of stock)
- It only allows for one product – Most businesses sell more than one product which makes it much harder to calculate the break-even point using this methodology
Because of its limitations, break-even analysis should be used alongside other forms of analysis, and shouldn’t solely by relied upon when you’re making important decisions.
What’s the margin of safety?
The margin of safety is a measurement of the gap between your break-even point and your actual or budgeted sales. It shows you how much of a cushion your business has before you start to incur losses (fall below your break even point) if sales decline.
This can be helpful if you want to work out how much you can drop your price in response to a new competitor or how safe your business is from a downturn in sales.
Working out your margin of safety is simple. The calculation is:
Margin of safety (revenue) = Actual/budgeted sales – Break-even point (revenue)
So for example, if your break-even point is £10,000 and your sales are £12,000, your business has a margin of safety of £2,000.
But margins of safety are usually expressed as a percentage, which you can work out as follows:
Margin of safety (%) = Actual/budgeted sales – Break-even point (revenue) ÷ Actual/budgeted sales
Using the example above, the margin of safety would be just over 16%.
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