Break even point is the easiest and most useful finance ratio to do decision analysis. You don’t have to have in depth finance knowledge to find BEP. In this post, we explain how to calculate break even point for every type of business.
Break Even Point Analysis ( BEP):
Before jumpting to calculation part, lets understand what is BEP and how it is useful to small business owners.
What is break even point ?
Break even point is the sales point when the business owner has no profit and no loss. In short, the business has covered all cost and it is ready to generate profit.
Formula to calculate break even point :
It is really easy to calculate BEP. However, you should have solid supporting number for the BEP reliability.
To calculate BEP, you should have knowledge of three components. Variable cost, sales price and fixed cost.
You can get this number from your income statement. You may not have these number while you are starting fresh business. However, you have do the market research and get estimated numbers.
Sales : Sales is the main revenue stream of business. It is the money you received in exchange of service or goods you sold.
Variable cost : Variable cost is the cost which varies by number of unit sold. Variable cost includes labor charges, inventory cost, power used, maintenance charges.
There is an advanced component of cost – semi variable cost. It remains fixed for certain units of production and varies after that. However, it is quite advanced for this article. You may get help of accountant to calculate semi variable cost.
Fixed cost : Fixed cost is the business expense remains fixed and not affected by number of unit sold. It includes advertising, rent, computer expense, administration staff salary, property taxes, license expense.
Contribution margin :
Contribution margin can be found by subcontracting variable cost from sales and then divide that amount by sales.
It is noteworthy that break even point can be calculated in two ways : BEP in terms of units and BEP in terms of amount ( Dollar).
To calculate BEP in units, you need to Divide fixed cost by difference of sales and variable expense per unit.
BEP (unit) = Fixed cost / ( Sales price per unit less variable cost per unit)
BEP ( Amount) = BEP ( unit) * Sales price per unit
BEP ( Amount) = Fixed cost / Contribution margin
Both formula gives the same result. I tend to use first formula during my study. You can see that first formula is easier than later.
Break even analysis Example:
Now, lets understand break even analysis with different examples.
Break even point for restaurant owner :
BEP is really useful for restaurant owners. Restaurant owner can use BEP while launching new branch or doing innovation with restaurant dishes.
Alice is thinking to start the restaurant. She has below fixed and variable cost. Lets calculate BEP in number of units for her.
Fixed cost :
Cafe rent: $2000
Other monthly administration cost: $650
Variable cost per unit:
Food items: $22
PPC cost per order:$1.5
Manger’s commission per order:$2.25
Sales per dish : $45
BEP in terms of dishes : Total fixed cost / (Sales per unit – Variable cost per unit)
Total fixed cost = $5250
Total variable cost per unit = $35.75
Break even point = $5250 / $45-$25.75 = 272.72 dishes
Break even point in terms of Amount :
We will just use simple method and multiply BEP ( units) with unit sales price to arrive BEP in amount.
BEP ( Amount ) =272.72* $45 = $12272.40
So Alice should have 273 dishes sold during the month to avoid the loss. Any dish sold over 273 will be clear profit for Alice.
Let say Alice has 350 dishes sold during the month. Then Alice has (350-273) *( $45-$25.75) = $1482.25 profit during the year. I just multiply number of units over BEP with contribution.
Break even point while launching new product line:
BEP is useful to startups as well as established business. Lets understand how to calculate BEP when you are launching new product.
Sarah is running fashion store business for three years. She is about to add unique hair product this year. She has estimated expense and revenue as per below. Lets help Sarah calculating BEP for new hair product.
Sales price of product : $115
Material cost : $30
Manufacturing cost : $45
Sales commission per unit : $7.5
Overhead per unit : $8.5
Additional monthly fixed cost : $16500
BEP ( Units) = $16500 / $115- ( $30+$45+$7.5-$8.5) = $16500/ $24 = 687.5 units
You may note that calculation of BEP is the same for new business and launch of new product line. However, we will consider only additional fixed cost for new product line launch.
Break even point importance:
Don’t under estimate usefulness of BEP. BEP is powerful tool which can save your thousand of dollars. BEP is useful in following ways:
Business profitability test: You can straight away test the business profitability without even launching. BEP is the simplest and most effective tool for decision making. It eliminates illusions and leads to better predictability.
Prediction of initial struggle: It is really hard to keep patience during initial years of business. But what if you can see small wins. With BEP, you can exactly decide your monthly or annual sales goal and stay patience during the struggle time.
Guide to cut cost: You can easily pinpoint whether it is your variable cost or fixed cost which is eating away your profit. You can take necessary steps to reduce or cut unnecessary cost. You can benchmark your cost with industry standard.
Measure profitability of scaling : Sometimes business may not be profitable at small production level but the profit margin increases with the increase in number of units.
Business loss alert: With BEP, you can estimate profitability of business. Break even analysis stops you to take wrong decision and you can avoid business loss. You can strike off wrong business venture without burning your hard earned cash.
No matter you are launching new business or want to experiment with new business product, BEP is helpful tool to check profitability, reduce unnecessary cost and take reliable decision.
Have you used BEP in your business? How it helped you? Let me know by commenting below.