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Break-Even Analysis: How to Calculate and Examples

Break-Even Analysis: How to Calculate and Examples; One of the first steps to starting a business is to assess finances. Learn how to calculate the break-even point for your business and how this ratio can help.
Kelly Boyer Sagert

Kelly Boyer Sagert

Updated July 7, 2021
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If you’re starting a new business, it’s important to assess its financial ratios and overall performance regularly so you can make appropriate adjustments for its stability and growth. One key assessment involves conducting something that’s called a break-even analysis.A break-even analysis determines how much revenue must come in to cover the business’s costs. In other words, this analysis shows how many products must be sold (or alternatively, how much revenue must come in) to bring the business to the point at which there isn’t a profit or a loss. That’s why it’s called the break-even point. You can express the break-even point either in terms of products you need to sell or revenues you need to break even. Using the current price of your product, it should be easy to convert from one format to the other.

Why Conduct a Break-Even Analysis?

The results of a break-even calculation can help you set or adjust pricing, create or modify your budget, and determine or tweak production goals. They can spur on cost-controlling measures and you can show them to your employees to demonstrate the benefits of reaching sales targets.Let’s look at just one example of how break-even analysis can be an important part of the small business budgeting and price setting processes. Some business owners don’t account for all of the costs that are involved in making a product when they set their prices. Direct costs—such as materials used in a product, manufacturing supplies, and direct labor costs—may be relatively obvious. But indirect labor costs, overhead costs, and others that are less obvious might not be properly accounted for. The result could be an under-priced product and a company that struggles to keep its books in the black. Break-even analysis can help you identify that situation so you can rectify it.So how do you calculate break-even points accurately and use them appropriately? To help you find the answers, here are some useful definitions and some strategies.

How to Calculate Break-Even Points

To understand this calculation, it can help to know the meanings of all of the factors used in it:
  • Fixed costs: These are the company costs that stay the same over a defined period of time. They are costs that have to be paid even when your company isn’t producing anything, like rent payments for building space, salaries, insurance payments, utilities on a budget, fixed loan payments, and so forth. 
  • Variable costs: These are costs that can vary based on business activity. One example might be sales commissions. If a team sells more products, then its commission amounts would increase. If it sells fewer, then this amount would decrease. You may need to estimate what these will be to arrive at a number to use in this equation.
  • Product sales price per unit: This is the cost that a business would charge a customer to buy one of its products. 
  • Contribution margin: This is the unit’s sales price minus its variable costs.

Example of Break-Even Analysis Calculation

The formula to calculate break-even point is Fixed costs ÷ Contribution margin = Break-even point (expressed in number of products)Let’s say that a company sells a technical guide and the fixed costs associated with it total $75,000; the variable costs involved in producing one guide equal $3; and the guide sells for $20. Then this is how this example of break even analysis plays out:The break-even quantity = $75,000 ÷ ($20-$3) = $75,000 ÷ $17 = 4,411.8; this company would therefore need to sell 4,412 copies of the technical guide to reach a break-even point.

Leveraging Break-Even Calculation Results

Picture discussing these results at a work meeting. The response may be that this is a wonderful break-even point. It could also be discouraging—or something in between. If results are deemed less than desirable, then a review of the business cash management plan, including pricing and more, may make sense.Solutions can include:
  • Raising prices
  • Finding ways to cut costs
  • A combination of cost-cutting and price adjusting
Here’s more information on these actions.

Pricing Strategies

When considering a price change, you’ll probably also want to think about what competitors are charging to make sure your company doesn’t price itself out of the market. If your prices would be higher than those other companies are charging, is your product more valuable in ways that can justify the higher prices?In certain industries, surge pricing (also known as dynamic pricing) could apply. In this situation, prices rise and fall based on market and customer demand. Concerts and other events might charge higher ticket prices if a certain performer is in high demand, for example. And hotel room prices can go up if the hotel is near a popular event. Assuming that company costs remain relatively stable, it will take fewer units to reach the break-even point when demand is high and prices are higher. It will take more units when demand and prices go down.A similar strategy sometimes called discount price strategy focuses on charging more for popular products. For example, the technical guide company may come out with another publication on a topic that’s highly relevant at present. At that point, the company may be able to sell this new publication at a higher price. But lowering it will likely lower that price when the novelty wears off. The idea behind this strategy’s name is that the product is put into clearance or otherwise discounted after a period of time. This strategy may work especially well with seasonal products or products that go in and out of style, such as clothing.If a company is just entering the market with a product that already has competition, it might use a penetration strategy in which it prices its offering very low so that the company can “penetrate” the market before raising prices. A break-even analysis would quickly show how larger numbers of products would have to be sold before costs could be covered. That’s why this is typically a short-term strategy to draw attention to a product and start earning revenue from it. This strategy is related to loss leader pricing, where a few products are priced exceptionally low to grab attention but other products are still sold at full price.

Cost-Cutting Strategies

Can materials needed for a product be purchased for a better price? What kind of discounts can the company get if the materials are bought in greater quantities? What impact could changes based on these factors have on cash flow management, overall? Ways to reduce fixed costs might include cutting back on rent, either by negotiating for better rates, moving to a smaller and/or less expensive space, or shifting to a partly or all-remote working model. This last option could help the business save money on rent, as well as on taxes, insurance, utilities, and so forth. If this seems like a possibility your business would like to pursue, check to see what local zoning and other codes may apply. If your cost for office space can be lowered, check to see what impact this has on the break-even points of your product(s).Returning to our earlier example of break-even analysis, let’s say that a new rental agreement will reduce the fixed costs of $75,000 by $15,000. Here’s what the break-even analysis would now look like:$60,000 ÷ ($20-$3) = $60,000 ÷ $17 = 3,529.4. This savings in rent lowered the number of technical guides that would need to be sold from 4,412 to 3,530.Other cost cutting measures that can lower the fixed costs include: 
  • Cutting back on vehicle expenses
  • Strategically using freelancers in the business
  • Price-comparing supplies
Plus, as the proverb has it, time is money. Finding ways to work more efficiently can be real money savers, too. Strategies include improving organization, using productivity apps, and outsourcing strategically.

The Takeaway

When you own a small business, you want it to make money. Understanding what your break-even point is and how to find it can help a lot. And using that tool to figure out what changes you might want to make in producing your products and in the fixed costs you pay may also be very valuable to your company’s bottom line.One more useful strategy: when your business needs to borrow money, one option that may be beneficial is to get the loan that offers the best deal for the company, from the interest rate to the fees charged. At Lantern Credit, you can fill out just one easy form to get multiple offers from our lending partner network. That allows you to compare and contrast your offers altogether in one place, which saves you time as well as effort.
The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC21036

About the Author

Kelly Boyer Sagert

Kelly Boyer Sagert

Kelly Boyer Sagert is an Emmy Award-nominated writer with decades of professional writing experience. As she was getting her writing career off the ground, she spent several years working at a savings and loan institution, working in the following departments: savings, loans, IRAs, and auditing. She has published thousands of pieces online and in print.
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