Break even point & analysis: Components & how to calculate it

Have you ever felt the exhilarating rush of starting something new? It could be a brand new business idea or the exciting prospect of expanding your existing venture. 

That initial spark is undeniable, but let’s be honest, it’s rarely without its fair share of costs and risks to navigate. That’s where the concept of the break even point (BEP) becomes your secret weapon.

Notably, understanding BEP and performing a break even analysis highlights the minimum revenue you need to cover costs and sustain your brand over time.

It also reveals when your business starts generating profits. These metrics will guide your investment of time and money. 

Ready to learn more about them? 

Read on as we explore more details.

What is break even point?

Break even point is a level at which a business's sales equal its expenses. It implies a transition from loss to profit. 

At this level, all business costs are covered, and subsequent sales become pure profit. 

Many individuals today continue to explore ways to start a business and make a profit. A recent Enterprise Nation study revealed that one in three adults have considered launching a startup. 

Certainly, the goal of any business is to be profitable. 

But is it possible to know when? That’s precisely what the break even point assesses. 

Notably, 20% of companies incur losses in their nascent stages. 

As such, understanding BEP is vital for new businesses. It helps you make informed decisions about pricing, cost management, and sales strategies.

Do you want to free up cash flow and avoid bad debts? Explore our cash ratio guide for more expert tips.

How to calculate break even point

Knowing your BEP is key to achieving and sustaining profitability. 

Calculating this metric is very straightforward. Using the practical scenarios below, let’s take a look at how to calculate break even point.

Break even point, based on units

To find out how many units you need to sell before you break even (BE), use this formula:

Fixed costs, such as rent and salaries, remain unchanged regardless of sales volume. Variable costs imply the cost of raw materials, hourly labor, and sales commission.

Scenario: Imagine you own a coffee shop, and your fixed cost is $1,000 for rent and salaries. 

You sell each cup of coffee for $5, and the variable cost (coffee beans, cups, labor) is $3 per cup.

Your BEP in units would be $1,000($5-$3)  = $1,000($2)  = 500 cups

Therefore, you’ll need to sell 500 cups to cover your fixed costs.

Break even point, based on sales (in fiat)

To determine the BEP in sales, divide the fixed cost by the contribution margin ratio. This ratio is the contribution margin divided by the selling price (or revenue).

1. To get the contribution margin, we subtract the variable cost from the product’s selling price. 

Contribution margin = Price of product – Variable cost

Scenario: Using the coffee shop example, the contribution margin per cup is $5 - $3 = $2 

2. The formula for the contribution margin ratio is: 

Contribution margin ratio = Contribution margin ÷ Selling price

The contribution margin ratio now becomes:

$5-$3($5)  = $2$5  = 0.4 or 40%

(c) Therefore, your BEP in sales would be:

$1,0000.4  = $2,500

Thus, you need to generate $2,500 in sales to BE.

Profit after BE

This is the sweet spot for every business. Once sales surpass the BEP, every additional sale becomes pure profits.

Scenario: Any additional revenue is profit if your coffee shop surpasses the $2,500 BEP. For example, if you generate $7,500 (that is, sell 1,500 units within a period) in sales, your profit would be:

$7,500 - $2,500 = $5,000

Overall, calculating your BEP at the initial stages can help you set prices, manage costs, and plan for growth as your business moves toward profitability.

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Understanding break even analysis

Break even analysis is a powerful economic tool that helps determine a company’s cost structure and the number of units it needs to cover costs. It explores the relationship between fixed costs, variable costs, and revenue.

Companies with low fixed costs typically have a lower BE point, making it easier to cover expenses and scale faster. This is beneficial because, according to an Iwoca report, big banks have a reduced appetite to fund SMBs. 

Thus, a company with a low BEP may not need to receive loans or fall into debt. 

Now, the million-dollar question is when should you conduct a BE analysis? 

The answer is: “As soon as possible.”

When starting a new business, this analysis helps assess your ideas’ viability and how to structure your pricing better. This can be crucial when launching a cost-intensive product. 

As such, you’re aware of the financial implications before making your first sale.

Moreover, any significant business adjustment, such as adding a new sales channel or changing your distribution model, can alter costs. 

Therefore, a BE analysis ensures you stay on top of these changes while maintaining stability.

Why should you know your business’ break even point?

A business owner must understand their break even point. 

You may wonder why. 

For starters, it identifies the minimum sales you need to cover expenses. 

As such, it helps you set the right price for your products or services in order to generate sufficient revenue and become profitable.

Without this knowledge, pricing becomes a gamble. 

Also, with the impact of inflation, you may find it challenging to break even and become sustainable. 

Furthermore, this concept empowers you to make informed decisions about business expansion, purchasing new equipment, or hiring additional staff. 

While opportunity cost can assist when faced with multiple choices, BEP gauges the additional revenue required to cover unforeseen costs and maintain profitability over time.

Importantly, your BEP should include your salary. 

According to Joshua Sherrard, from Strategic Navigators Inc., cited in a Forbes article, many business owners make the mistake of not paying themselves adequately, which has an adverse effect on personal financial stability.

Including your salary in expenses ensures your business’ longevity and future success.

Components of break even analysis

Break even analysis consists of five key components. These elements help businesses set prices, control costs, and plan for profitability. They include the following:

Fixed costs

These are expenses that remain constant regardless of sales. This includes rent, salaries, and insurance.

Variable costs

These costs, including materials, labor, and utilities, vary with production levels.

Revenue

This is the total income from sales, calculated by multiplying the price per unit by the number of units sold.

Contribution margin

It represents the profit per unit sold after covering variable costs. It’s calculated by subtracting variable costs from the selling price.

Break even point 

At this point, total revenue equals total costs, meaning you’re not making a profit but not incurring a loss either.

Advantages of break even analysis

A BE analysis is vital for any business. It offers numerous benefits that drive better choices and strategic planning. Let’s consider some of them below:

It determines sales targets

When you understand the number of units you need to cover costs, it helps you set precise sales targets.

The analysis considers the variable costs, selling prices, and total expenses, helping you pinpoint how much you need to sell to break even.

It facilitates easy budgeting and ensures a safety margin

Knowing your business’ break even point allows you to establish realistic financial goals and budgets. This foresight ensures your company always aims for achievable targets. 

Additionally, sales often dip during financial downturns. 

Consequently, conducting a BE assessment identifies the minimum sales required to stay profitable. 

With this insight, you can make critical decisions to navigate tough times and maintain a buffer against potential losses.

It monitors costs

Profit margins are influenced by fixed and variable costs. 

Break even analysis helps detect changes affecting these costs so businesses can implement corrective measures promptly and safeguard their profitability.

It guides pricing strategy 

Adjusting a product’s price can impact your BEP. If you raise prices, you need to sell fewer units to break even; if you lower prices, you need to sell more. 

So, a thorough analysis helps design effective pricing strategies that align with your financial goals.

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Limitations of a break even analysis

While a BE assessment is important, its limitations must be recognised, especially for SMBs. Here are some of them.

BE analysis cannot predict market demand

Break even analysis can tell you when you’ll BE, but it doesn’t provide any information on whether reaching that point is realistic. 

Since market demand is often unstable, your BEP might be harder to achieve than you initially expected, even if you see opportunities to grow.

It relies on accurate data

The effectiveness of a break even assessment hinges on your data accuracy. 

Inaccurate calculations or fluctuating costs can render the analysis less valuable, which can misguide your decisions.

It is oversimplified

This analysis is excellent for businesses with a single price point. 

However, it may be too simplistic for companies with multiple products and prices. 

Also, changing costs requires regular evaluation of your break even point.

Given these limitations, it’s prudent to complement break even analysis with other profitability metrics like net profit margin or return on assets.

This holistic approach ensures a more comprehensive understanding of your business’s financial health, allowing for better-informed choices.

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Unlock growth with our financing options

Understanding your break even point and conducting a thorough analysis is crucial to becoming profitable and making informed business decisions. 

But what if you need immediate liquidity to manage accounts payable or fuel growth, especially in overseas trade with delayed payment terms?

Stenn offers the perfect options. By financing invoices for small and medium-sized businesses, we provide the cashflow you need for optimal operations. 

We also offer revenue-based financing tailored for eCommerce and SaaS businesses. Explore our financing options today and discover how we can support your business growth.