One of the basic measures of success is whether your company is making enough money to cover its expenses. While success can be measured in clients’ happiness and the satisfaction of your workers, being able to run your finances smoothly is important.
Your break-even point as a company is the point at which your business is making enough money to cover its operating costs and is not incurring a loss. Being able to calculate your break-even point gives you an accurate picture as to what your prices should be and where you need to cut down on expenses for good cash flow management.
According to a study referenced by the National Federation of Independent Business (NFIB), 82% of businesses fail because of poor cash flow management or a poor understanding of its concept. Incorrectly balancing your business’s books or declining to do so places your business in a potentially dangerous economic position. Understanding what your break-even point is and how to calculate it is key.
What Is the Break-Even Point?
If your revenue is below the break-even point, your business is incurring a loss. If the company’s revenue sits above the break-even point, you are making a profit.
Many industries use this calculation to ensure adequate cash flow, including those operating in manufacturing, healthcare, hospitality, and retail. Calculating your break-even point involves knowing what your fixed costs are, as well as your variable costs per unit, and your sales price per unit.
Your fixed costs often involve financial duties that typically stay stable over time and can include items like:
- A lease.
- Mortgage payments.
- Property taxes.
- Utilities.
- Interest expenses.
Variable costs in business fluctuate or depend on external factors. This can include your money put towards paying for things like:
- Raw materials.
- Wages.
- Commissions.
- Packaging.
- Piece-rate labor.
- Staffing costs.
- Credit card fees.
Organizations that face a shortfall when it’s time to pay bills — including payroll — may turn to factoring services to stay operational until they can adjust cash flow to cover all expenses.
The last part of the equation would be the sales price per unit. It consists of the amount of money you would make by selling one unit of your product or service.
Break-Even Point Formula
The break-even point formula involves using one of two equations. You can calculate your break-even point using your sales per unit or your sales per dollar. Let’s take a look at each calculation.
Per Unit
To calculate your break-even point using sales per unit, divide your fixed costs by your
contribution margin per unit, or your sales per unit-variable costs per unit.
The break-even units formula is:
Break-Even Point in Units = Fixed Costs
_________________________________
(Sales Per Unit -Variable Cost Per Unit)
This calculation will give you the total amount of units of a product you need to sell in
order to break even.
Per Sales Dollars
To calculate your break-even point based on sales per dollar, multiply the price of
each unit by your breakeven point in units.
The break-even point in sales dollars formula is:
Break-Even Point in Dollars = Sales Price per Unit x Break-Even Point in Units
The result of this equation will provide you with the total sales you need to achieve to break-even or to have zero losses and zero profits.
Examples of Calculating Break-Even Point
There are plenty of situations in which you would need to calculate your break-even point, so let’s take a look at a typical scenario where it would be used.
Imagine you own a healthcare supply company. Your company delivers medical supplies to hospitals, doctors’ offices, and other medical establishments. To calculate your break-even point in units, you need to first determine what your fixed costs are, as well as your sales per unit and your variable costs.
- Your fixed costs may consist of the salaries you pay your employees and the rent you pay on a warehouse where medical supplies are stored before they’re sold and delivered. Let’s say these costs add up to $500,000 per month.
- Your sales per unit represents the revenue you bring by selling your medical supplies, such as boxes of disposable latex gloves. Let’s say this adds up to $500 per month.
- Your variable costs per unit would consist of the purchase of the medical supplies from the original manufacturer, and your gas bill for the office and warehouse. Let’s say these add up to $300 per month.
By using the break-even point in the units equation above, the result would equate to 2500. In this scenario, you would need to sell 2500 units of medical supplies per month to break even and cover all your costs. If you sell more than 2500 units, you would make a profit.
Using the break-even in total sales equation, you would need to sell $1,250,000 worth of medical supplies to break even. Anything sold above this is a profit and anything lower would require operating at a loss. As a result, your medical supplies business may require factoring services to make up for the shortfall and cover your expenses.
Performing a break-even point analysis is important to the ongoing economic health of your company and integral to ensuring you have adequate cash flow at all times. Take a second look at your business’ finances yourself when you’re first starting, or whenever your expenses or revenue changes. By doing this, you can determine if you need to raise your prices and/or make cuts to your expenses to both break even and remain profitable.
How can you use a financial statement template to calculate break-even figure?
A financial statements template can be used to accurately calculate margin, markup, and break-even figures for your business. By regularly reviewing your financial statements using this template, you can ensure that your calculations are correct and identify any potential increase in expenses that may result in unnecessary financial losses.
To utilize the financial statements template effectively, simply enter your sales and expenses information into the profit and loss, balance sheet, and cash flow sheets provided. This template serves as a comprehensive tool to create your own profit and loss (P&L) statement, balance sheet, and cash flow statement.
Within the template, you will find example figures for a hypothetical business called Joe’s Tyres. By comparing the figures in the template with the examples provided, you can gain a deeper understanding of how to interpret and calculate margin, markup, and break-even points specific to your own business.
Regularly utilizing the financial statements template in this manner will enable you to keep track of your financial performance, identify any possible discrepancies or inefficiencies, and ultimately make informed decisions to optimize your business’s profitability and success.
How Can You Review Your Financial Statements To Ensure Accurate Break-Even Calculations?
To ensure accurate margin, markup, and break-even calculations, it is essential to regularly review your financial statements. By following these steps, you can effectively assess and verify the accuracy of these important calculations:
1. Schedule Regular Reviews: Set a specific time frame to review your financial statements, whether it’s monthly, quarterly, or annually. Consistency is key to staying on top of any changes or discrepancies.
2. Gather Necessary Information: Collect all the relevant financial documents such as profit and loss statements, balance sheets, and cash flow statements. These forms will provide the necessary data for your calculations.
3. Verify Sales Figures: Begin by examining your sales data to ensure they are accurately recorded in your financial statements. Verify that all sales transactions have been accounted for, including any returns or discounts that may impact the final figures.
4. Evaluate Expenses: Scrutinize your expenses to confirm that they have been correctly recorded. Look for any discrepancies or missing entries that could affect the accuracy of your calculations. Pay special attention to any significant changes or unexpected variances in expenses.
5. Double-Check Cost of Goods Sold: Review your cost of goods sold (COGS) calculation to ensure that it accurately reflects the direct costs incurred in producing your products or delivering services. Verify that all costs, such as raw materials, labor, and overheads, are included.
6. Calculate Gross Profit Margin: Use the information from your sales and COGS to calculate your gross profit margin. Divide your gross profit by your sales revenue, and multiply by 100 to get the percentage. Compare this figure to your previous calculations and industry benchmarks to assess its reasonableness.
7. Assess Markup: Analyze your pricing strategy by calculating your markup. Divide the gross profit by the cost of goods sold and multiply by 100 to determine the markup percentage. Consider whether this markup aligns with your business goals and market demand.
8. Determine Break-Even Point: Calculate your break-even point by dividing your fixed costs by the difference between your selling price and variable costs per unit. This will help you understand at what level of sales you are covering all your expenses and not incurring any losses.
9. Utilize Financial Statement Templates: Leverage financial statement templates to facilitate accurate calculations. These pre-designed templates can help streamline the process by standardizing the formatting and formulas used in your calculations.
By regularly reviewing and scrutinizing your financial statements in this manner, you can confidently identify any errors, fluctuations in expenses, or inconsistencies in margin, markup, or break-even calculations. This diligent approach will enable you to avoid potential financial pitfalls and ensure the financial health and success of your business.
How To Set Prices To Earn A Profit
To set prices for goods in order to earn a profit, there are several calculations and factors to consider:
1. Gross Profit/Margin: Calculate the gross profit by subtracting the cost of goods sold (COGS) from net sales. Gross margin is then determined by dividing the gross profit by net sales and multiplying by 100. This provides insight into the profitability of each unit sold, indicating the amount left after covering the direct costs.
2. Net Profit/Margin: To determine the net profit, subtract the total of both COGS and overhead expenses from net sales. Alternatively, you can subtract the overhead expenses from the gross profit. Net margin is then calculated by dividing the net profit by net sales and multiplying by 100. This indicates the amount of profit made after considering all expenses.
3. Markup: Markup refers to the percentage that goods are sold for above their cost. To calculate the markup percentage, divide the difference between the sales price and COGS by COGS, then multiply by 100. This helps ensure that the sales price covers not only the cost of goods but also overhead expenses, allowing for profit.
4. Break-Even Point: Knowing the break-even point is crucial to understand the minimum sales required to cover expenses and start making a profit before taxes. The break-even point can be determined in dollar value by dividing the overhead expenses by (1 – (COGS divided by total sales)). Alternatively, to calculate the break-even point in units, divide the overhead expenses by the difference between the unit selling price and the unit cost to produce.
By considering these calculations, businesses can establish appropriate prices for their goods that will cover costs, generate profit, and ultimately lead to financial success. These calculations also assist in setting sales targets and planning for profitability within a business plan.
