What is Break even?
If you’re reading this, then you probably already know the answer to “what is break even”.
But here’s a run down just to give you some extra information.
Break even analysis is a fancy name for the process of measuring the balance between the costs and profits.
It helps you to measure the point where your business is just covering operating costs.
If your sales fall below the break even point then you’re operating at a loss. Being on the Break even point is when you’re making enough to cover for your expenses.
And going above the BEP is where you want to be, because that’s where you’re making a profit.
Benefits of Analysing Break Even Point
Making Decisions and Predictions Based on Data
There are a number of benefits that come with analysing and calculating your break even point. Essentially it lets you know where you are in terms of profitability.
You can also use a break even chart to make some fairly accurate predictions, like if you’re going to hit a profit, when you’ll hit a profit and how much of a profit you will make.
That’s all useful, but the biggest reason to measure your break even is because it gives you an idea of how much products you need to sell to hit a profit.
Investors Love Charts!
Another benefit of calculating your BEP is that investors love break even analysis, if you have a clear understanding of your profit margins it will help them to understand the viability of your business proposition.
Which gives them a higher chance of investing in your business.
Keeps You Grounded
Break even analysis also shows the importance of keeping fixed costs at a minimum, especially for startups.
Keeping fixed costs low makes up for the unpredictable nature of variable costs which can sometimes prevent you from hitting that break even point!
As great as break even analysis is, there are limits to what you can do with your break even point and profit margins.
For example, having unrealistic expectations can render a break even chart useless, so you need to base your expectations on current profit and sales.
Another thing to be vigilant of is that realistically fixed costs aren’t always fixed. They can be varied when sales output changes.
This may not be drastic or instant, but it is worth keeping in mind when examining break even metrics.
Also remember that most businesses sell more than one product so it can sometimes be difficult to track the break even point for a business overall.
Depending on your business it could be more beneficial to work out the break even point for each product.
How to calculate break even?
Above we’ve discussed what the break even point is and why it’s important, so now we’re going to tell you how you can work out your own break even point.
Don’t forget you can also use our own Break Even Calculator above!
There are two methods we can use to work out the BEP.
One of these methods will help us work out the Break even point in units (the number of units needed to be sold to break even) and the other in sales (revenue needed to be generated to hit break even.)
Fixed Costs/Contribution Per Unit = Break Even Results in Units
This formula is used to work out the break even point in units, what this means is the answer you will get from working out this equation is the number of products you need to sell to break even.
The metrics used in this formula are the fixed costs and the contribution per unit.
The fixed costs are essentially costs that are always the same (more or less) an example of fixed costs is the hosting you’d pay for your website.
This cost is usually exactly the same but can be altered in certain circumstances.
And the contribution per unit is the difference between the revenue made and the variable costs divided by the total number of units produced.
This is gives the profitability of each product and how much variable costs were spent on individual units.
Total Revenue – Variable Costs/Total Units = Contribution Per Unit
As discussed in the fixed costs, the contribution per unit is the amount of variable costs spent on each product and how much profit those units made.
The formula consists of two metrics which are pretty straight forward, The variable costs which are costs that change every month. Examples of these are raw materials or packaging.
And the total revenue is how much you would have made on that month.
Fixed Costs/ Contribution to sales Ratio = Break Even in Results in Sales
This formula is used to work out the break even result much like the first formula, however when you use this method you will have the answer in Sales rather than units.
Much like the last few equations this one uses fixed costs. The other metric used is the contribution per unit, this is basically how much of each sales dollar value can make up for the fixed costs.
The contribution to sales ratio is worked out by dividing the contribution per unit by selling price per unit and then multiplying by 100.
This will give you a percentage for your contribution sales to ratio.
Contribution Per Unit/Selling Price Per Unit*100 = Contribution to sales ratio
This formula is used to work out the contribution to ratio as a percentage, and is quite straightforward.
The formula above goes over the contribution to sales ratio in a little more detail.
So which of these two formulas do you use to work out your break even? Well it all depends on if you want to work out your breakeven in sales or units.
Depending on if you’re doing an analysis for one product or for your whole business and depending on which of these you’re more comfortable with.
Using your result in units you should be able to work out your results in sales as well
How to reduce your break even point?
There are a number of ways to reduce your break even point.
Simply put you want to find a way to reduce your costs and increase your contributions. Here are a few simple in principle ways to reduce your BEP.
Reduce Fixed Costs
The first method to reduce your BEP is to look at reducing your fixed costs.
If you can reduce your fixed costs and keep your product quality the same, then overall you’re going to be spending less whilst maintaining revenue.
For example if you were running a clothing store from a warehouse with a rent of $500 a month and decided shift products home to save money you’d be saving $500 but ideally making the same amount of revenue.
Having less fixed costs makes it easier for you to make up for those costs which sales which in turn reduces your break even point position.
Reduce Variable Costs
Another thing you could do to reduce your Break even point position is to reduce your variable cost per unit, an example of this could be if you’re selling bread you could use some cheaper flour.
This would reduce your variable cost per unit, in turn reducing the Break even point position.
And the final method to Improve the Break even point position is to increase the selling prices. . This is a risky move, as it could impact the number of sales, but depending on your customers and their loyalty it could be worth it.
At the end of the day break even analysis is great, but it’s always good to have realistic vision when dealing with break even charts. Break even charts aren’t always accurate.
They’re a good guide for where you should be at and what you can do to get there.