How to Calculate the Break-Even Point

When putting together a new business plan, launching new products or making changes to systems and structures that could add costs, it's essential to know how this will impact your finances and identify at what point you'll be able to meet all of your outgoings. This will allow you to plan with confidence and budget appropriately. To do this, you'll need to identify your break-even point.

What is the break-even point for a business? 

The break-even point is when a business's income is equal to its expenses. It is determined via break-even analysis which looks at fixed costs, variable costs, price per unit and number of units. The break-even point is calculated as follows:

Contribution per unit = revenue per individual unit minus the expenses per unit Break Even point = Fixed costs divided by Contribution per unit.

A positive or negative result will show whether the business is operating at a profit or a loss.

Calculating your break-even point 

Your total revenue per month should be at least equal to your total equal total costs to break even. The formula to calculate this is:

Total revenue = Unit sale price × Unit sales Total costs = Fixed costs + (Unit variable cost × Unit sales)

If you're starting a new business, you may not have full clarity on all of these aspects, but you can break it down further. For example, if you're not sure of your unit sales (whether products or services), you can calculate this first:   Total fixed costs ÷ (Unit sale price – Unit variable cost) = Unit sales per month

 Total fixed costs can be determined by calculating:   (Unit sale price × Unit sales) – (Unit variable cost × Unit sales) = Total fixed costs

How to calculate the break-even point for services?

As a service business it can be difficult to identify unit price or cost, so your break-even point can be calculated slightly differently. For example, you could use:

(Overhead costs + balance sheet payments) / Gross margin

If you wanted to dig down further you could work out how many clients or how many billable hours you need to accomplish in order to break even. For example a consultancy business could take their costs and average client selling price to work this out:

Total Fixed Cost / (Selling Price – Variable Cost)

Similarly, an accountancy firm that bills by the hour would need to identify fixed and variable costs plus their usual hourly rate:

Total Fixed Cost / (Selling Price – Variable Cost)

How to use a break-even analysis 

But what value does knowing your break-even point bring to a business and does it do more than tell you how much revenue you need to generate? The short answer is yes. Knowing your break-even point can help you delve deeper into numerous parts of your business. For example, it will highlight if your prices are too high or too low and help you identify if you need to reduce your costs to be sustainable. It will also highlight if your plans are realistic. If the number of units you need to sell, or the number of hours you need to bid for, is higher than what you think is achievable, you need to have a rethink before going to market. In this way, break-even analysis can help you avoid making costly mistakes. It can also assist with goal setting, not just by identifying the number of units you need to sell but also by helping you to make clearer decisions around longer-term planning. For example, if the goal is to move into larger premises, this will likely result in higher fixed costs. Break-even analysis will help to identify when this will be achievable.

What increases the break-even point? 

Your break-even point will change at different times depending on several circumstances, some of which you may be able to influence, some of which it may be more difficult to affect.

The most common change will be increased fixed costs such as rent, salaries and utilities. Similarly, if variable costs increase without an equivalent increase in revenues, the break-even point will increase to make up for the loss. If there's a decrease in the company's selling prices or an unfavourable change in the mix of products/services sold, your break-even point could also be affected.

What if the break-even point is negative? 

If the break-even point is negative, it means your costs outweigh revenue, so the company is operating at a loss. While this may be sustainable in the short term, it will be essential to take action to improve this situation – an acceptable break-even window is generally seen as six to 18 months. Steps to consider include trying to sell more units or raising the selling price of the product to increase revenue and profitability. It may also be possible to reduce costs to help improve this balance, although any of these moves must be carefully considered.

Next steps once you've calculated your break-even point 

Your break-even analysis will give you a strong indication of whether a new business, product launch or expansion strategy will be profitable and how long it will take for this to happen. You can use the information it gives you to decide on a pricing strategy, set clear sales revenue targets and make decisions based on facts and data. It will also limit the financial toll that bad decisions can have on your business and ensure you're moving forward with a realistic idea of what the future could hold.