Accounting 101: Break-Even Point Formula

What is the break-even point?

In accounting, the break-even point is the number of unit sales at which your production costs equal your revenues, resulting in a net zero. Selling any more means you’ll start to see a profit, and selling any fewer means you’ll suffer a net loss.

Business owners often use the break-even point formula to determine the minimum number of sales they have to reach and then set incremental goals that help them stay on track for their desired revenue numbers.

Notably, you can calculate the break-even point for individual product lines or your entire business. Both can be helpful for informing goals, setting your prices, and forecasting your profits.

Break-even point formula.

The break-even point formula is as follows:

Break Even Point = Fixed Costs of Production ÷ (Sales Price Per Unit – Variable Costs of Production Per Unit)

Fixed costs refer to the expenses that remain the same regardless of increases or decreases in your sales and production volume. They usually aren’t directly related to the production process. For example, some common fixed costs include office rent, loan interest, property insurance, and administrative salaries. 

Variable costs are expenses that correlate directly with your sales or production volume. The higher your output, the higher these expenses become, and vice versa. Some examples of variable costs include direct labor and direct materials.

Finally, your sales price per unit refers to the rate at which you sell your products or services. For example, if your graphic t-shirt business sells each shirt for $20, your sales price per unit is $20.

How to calculate the break-even point.

Let’s go over an example to help you understand how you would calculate the break-even point in practice.

Say you start a small personal training agency and charge your clients $50 for each hour they spend with your trainers. You pull the following expense information from your financial statements and other data sources for 2020, your first calendar year of operations:

• Rent: $15,000
• Insurance: $3,000
• Advertising: $2,000
• Direct labor: $25 per hour

Your business’ fixed costs would include the rent, insurance, and advertising since they’re not directly related to your services and remain static no matter how much of your services you manage to sell.

Meanwhile, your direct labor expense, the $25 per hour you pay the personal trainers you’ve hired, is your only variable cost. The more clients you convince to sign up, the more that total cost will increase.

With those categories established, we can plug our numbers into the break-even point formula to determine how many hours of personal training you’d need to sell to pay for your business costs. Here’s what that would look like:

$15,000 rent + $3,000 insurance + $2,000 advertising = $20,000 fixed expenses

$20,000 fixed expenses ÷ ($50 sales price per unit – $25 variable expenses) = 800 units

That tells us you must book enough clients to sell 800 hours of personal training services to break even. If you can sell more than 800 hours, your agency will be profitable. If you can’t, your operation will lose you money.

How to decrease your break-even point.

Sometimes, you’ll calculate your break-even point and determine that you’re unlikely to sell enough units to be profitable. That’s a cause for concern, but it doesn’t necessarily mean your business model isn’t viable.

If you can’t sell enough units to reach your current break-even point, consider changing the other variables in the formula to increase your chances of profitability. In other words, try raising your prices or looking for ways to reduce your costs.

Using the same fitness agency from the previous section as an example, imagine you increase your hourly rates from $50 to $60 and pay each of your personal trainers $20 per hour instead of $25.

Your new break-even point formula would look like this:

$20,000 fixed expenses ÷ ($60 sales price per unit – $20 variable expenses) = 500 units

With those changes, you’d have to sell 300 fewer units to reach your break-even point, which might be more attainable.

How to use the break-even point formula.

Calculating the break-even point for your product or service tells you exactly how many units you need to sell to cover your business’ expenses. That’s a critical component of financial planning and can be especially useful for goal setting and forecasting.

Let’s use the example from the previous sections to demonstrate. Since you need to sell 800 hours of training services to break even, you could hire three personal fitness agents and aim for each of them to work 20 hours per week.

You can use these assumptions to determine how long it would take to reach your break-even point. Here’s what that calculation would look like:

800 hours ÷ (3 agents × 20 hours per week) = 13.33 weeks

If you started your business on the first day of the calendar year, you’d reach your break-even point in early April.

Taking it one step further, you can even use the break-even point formula to project your net profit for the year. For example, let’s assume your team of three works 20 hours per week for 48 weeks of the year.

Your break-even point formula tells you that you’d earn $25 each hour they work. It also tells you that your annual fixed costs are $20,000. Knowing all that, here’s how you’d calculate your projected profit by tweaking your break-even formula:

3 agents × 20 hours per week × 48 weeks per year = 2,880 hours per year

($50 selling price per unit – $25 variable expenses) × 2,880 hours – $20,000 fixed costs = $52,000 net profit for year

Forecasting your business’ profit like this is incredibly useful during financial planning. Not only can it help you set realistic goals and create informed budgets, but it also helps you adjust your plans if your sales don’t match your expectations.

_{Information provided on this blog is for educational purposes only, and is not intended to be business, legal, tax, or accounting advice. The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. While Lendio strives to keep its content up-to-date, it is only accurate as of the date posted. Offers or trends may expire, or may no longer be relevant.}