What’s a break-even point?
The break-even point for a business or company is when its revenue equals its expenses. The company is “breaking even,” so money going out is equal to money coming in.
Also called (BEP), the break-even point occurs when the amount of money a company makes is equal to the amount it must spend to cover all the costs of running the business (“overhead costs”) and producing products for sale (“direct costs”).
A company’s revenue must exceed its break-even point for it to turn a profit.
Why is it important?
The BEP calculation tells management how easy or difficult it will be for the business to succeed. The higher the BEP, the more difficult it will be for the company to turn a profit. Especially for new businesses, keeping the BEP as low as possible is crucial.
This is why online companies that sell services and don’t have physical inventory can become successful more quickly than a physical business that must rent a building, insure and staff the store, and house products for sale.
The BEP calculation can also:
- Help a company ensure that it’s on track to achieving its goals
- Help a company analyze product pricing
- Highlight which expenses are too high
With each additional product produced and sold, a company’s total cost of doing business goes up, but so does its total revenue.
Factors to consider:
- Overhead Costs
- Wages for administrative staff
- Direct Costs
- Cost of raw materials
- Cost of production
- Wages for manufacturing staff
- Product sale price
Gross margin percentage
To calculate where a business’s costs and revenue even out, you need to know how much of its product’s sale price goes toward production versus profit. The percentage of the sale price that is kept as profit is called the “gross margin percentage.”
Company ABC produces gizmos.
- Production Cost: $3
- Sales Price: $5
- Profit: $2
- Gross Margin Percentage: $2 / $5 = 0.4, or 40%
Calculating the break-even point
BEP = Total Overhead Costs / Gross Margin Percentage
By dividing the total overhead costs by the gross margin percentage, the break-even point formula determines exactly how much sales revenue a company must produce to cover all its costs.
The result can then be divided by the sale price of the product to determine how many items the company must sell to break even.
Now assume that company ABC has the following expenses:
- Annual Overhead
- Rent: $12,000
- Utilities: $2,500
- Insurance: $2,000
- Administrative Wages: $45,000
- Total Overhead: $61,500
- Direct Cost Per Gizmo
- Raw Materials: $1.50
- Labor: $1.50
- Total Direct Cost: $3
If each gizmo sells for $5:
Gross Margin Percentage = $2 / $5 = 0.4, or 40%
BEP (Dollars) = $61,500 / 0.4 = $153,750
BEP (Gizmos) = $153,750 / $5 = 30,750
Company ABC must generate $153,750 in revenue to break even, which requires selling 30,750 gizmos per year.