How to Calculate Break Even Point Formula

The break even point is the level of sales or production at which a business neither makes a profit nor incurs a loss. It's a crucial financial metric that helps businesses understand how many units they need to sell to cover all costs and start making a profit.

What Is Break Even Point?

The break even point is the point at which a business's total revenue equals its total costs. At this point, the business has covered all its expenses and starts generating profit. Understanding the break even point is essential for businesses to plan their operations, set pricing strategies, and manage financial performance.

There are two main types of break even points:

Absolute break even point: This is the point where total revenue equals total costs, including fixed and variable costs.
Relative break even point: This is the point where total revenue equals variable costs only, ignoring fixed costs.

The absolute break even point is more commonly used as it provides a more comprehensive view of a business's financial health.

Break Even Point Formula

The break even point can be calculated using the following formula:

Break Even Point = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)

Where:

Fixed Costs: These are costs that do not change with the level of production or sales, such as rent, salaries, and insurance.
Selling Price per Unit: This is the price at which each unit is sold.
Variable Cost per Unit: These are costs that vary with the level of production or sales, such as raw materials and direct labor.

To calculate the break even point in monetary terms, you can use the following formula:

Break Even Point (in dollars) = Fixed Costs / (1 - (Variable Cost per Unit / Selling Price per Unit))

Note: The break even point formula assumes that the selling price per unit is greater than the variable cost per unit. If the selling price is less than or equal to the variable cost, the business will never reach the break even point.

How to Calculate Break Even Point

Calculating the break even point involves several steps:

Identify your fixed costs. These are costs that do not change with the level of production or sales.
Determine your variable cost per unit. These are costs that vary with the level of production or sales.
Find out your selling price per unit.
Plug these values into the break even point formula.
Calculate the break even point in units or monetary terms.

It's important to ensure that your selling price per unit is greater than your variable cost per unit. If it's not, the business will never reach the break even point.

Example Calculation

Let's consider a business with the following details:

Fixed costs: $10,000
Variable cost per unit: $5
Selling price per unit: $10

Using the break even point formula:

Break Even Point = $10,000 / ($10 - $5) = $10,000 / $5 = 2,000 units

This means the business needs to sell 2,000 units to reach the break even point.

To calculate the break even point in monetary terms:

Break Even Point (in dollars) = $10,000 / (1 - ($5 / $10)) = $10,000 / 0.5 = $20,000

This means the business needs to generate $20,000 in revenue to reach the break even point.

Interpretation

The break even point provides several insights for businesses:

Financial Planning: Businesses can use the break even point to plan their financial activities and ensure they have enough resources to cover their costs.
Pricing Strategy: Understanding the break even point helps businesses set appropriate prices for their products or services.
Performance Evaluation: By comparing actual sales to the break even point, businesses can evaluate their performance and make necessary adjustments.

It's important to note that the break even point is a theoretical concept. In reality, businesses may face additional challenges and uncertainties that can affect their ability to reach the break even point.

FAQ

What is the difference between absolute and relative break even point?

The absolute break even point considers both fixed and variable costs, while the relative break even point considers only variable costs. The absolute break even point is more commonly used as it provides a more comprehensive view of a business's financial health.

How can I reduce my break even point?

You can reduce your break even point by increasing your selling price per unit, reducing your variable cost per unit, or reducing your fixed costs. However, these changes should be done in a way that maintains the quality of your products or services.

What if my selling price is less than my variable cost?

If your selling price is less than or equal to your variable cost, your business will never reach the break even point. In this case, you need to either increase your selling price or reduce your variable costs.