break even analysis

What is the break-even point?

The break-even point is a critical number for every small business. Yet, many Canadian entrepreneurs don’t know the point at which sales will translate into profit. Let’s break down the break-even analysis and help you easily understand how it’s calculated.

Why is break-even important?

The break-even point is critical for entrepreneurs, because any money coming in over and above this number is profit! As well, knowing the break-even point can help an entrepreneur determine how much of an increase in sales is required to cover an increase in costs, and may be used when deciding whether to launch a new product.

How to calculate the break-even point

Break-even can be calculated using this formula:

Total Fixed Costs ÷ (Unit Price – Unit Variable Cost)

                                  (also known as contribution margin per unit)

To use this formula, the price of the product or service, per unit, should be known. Entrepreneurs will also need to know the variable cost, per unit, of the product. For example, variable costs for a shoe manufacturer could be the cost of the materials in each pair like leather, laces as well as that portion of labour that it takes to build each pair.

Next, subtract the variable cost per unit from the selling price per unit, to get the bottom part of the formula — the contribution margin per unit.

The top portion of the formula is total fixed operating expenses, things like a business’ rent, salaries not associated with manufacturing, utilities and so on.

For example, let’s say the selling price of an average bouquet at Jill and Lauren’s flower shop is $25. The variable cost of a bouquet, including materials and labour wages, is $5.00 per bouquet.

To figure out the contribution margin per unit, they subtract the variable cost per unit from the sales price. So, $25.00 – $5.00 = $20.00.

Let’s say the fixed costs of Jill and Lauren’s flower shop amount to $10,000. Now that they have all of our numbers, they can plug them into the formula to determine the break-even point, or the number of bouquets they’ll need to sell to cover their costs.

     $10,000                  =                      $10,000          =          500 bouquets
($25.00 – $5.00)                                      $20

Other analyses can be conducted with this knowledge. For example, product-focused businesses can take that number and divide it by the number of days they work per year to figure out how much they’ll need to sell each day to break even.

The break-even point in sales dollars can be determined by multiplying the break-even point in units by the selling price. This will give the entrepreneur the point where total sales equals total costs, in dollars.

For more insight into the break-even point and more, check out our online small business training – comprehensive but designed to fit around your busy schedule!

 

Share this post:

How to conduct a break-even analysis

A break-even analysis is a tool used by small business owners to calculate the amount of sales needed to cover all costs – the point when they break even. This can also be used to determine how much of an increase in sales you’ll need to cover your cost increase, and may be used when deciding whether or not to launch a new product. We’re looking for the point where Total Revenues are equal to Total Costs.

Here is the formula to calculate your small business’ break-even point:

Total Fixed Costs ÷ Contribution Margin Per Unit: (Unit Sales Price – Unit Variable Costs)

To use this formula, you need to know the sales price of your product or service, per unit. For example, let’s say you own a screen-printed t-shirt small business. The sales – or unit – price of one of your t-shirts is $20.00. You’ll also need to know the costs which vary with the amount of business you do, per unit, of your product. For example, the variable cost of a t-shirt, including materials, utilities and labour wages, is $5.00 per t-shirt.

Next, you want to subtract the variable cost per unit from the sales price to give you the contribution margin per unit. So, $20.00 – $5.00 = $15.00.

Now, to get the total fixed costs number, you must know total fixed operating expenses (costs that stay the same no matter how many t-shirts you make). Let’s say the fixed costs of your t-shirt shop, including rent, taxes, insurance, and all other unchanging costs that must be paid to keep your business running, amount to $10,000.

Now that we have all of our numbers, let’s plug them into the formula to determine the break-even point, or the number of t-shirts you have to sell to cover your costs.

$10,000 ÷ $15 = 666.67, or 667 t-shirts per year rounded up

If you need to sell 667 shirts a year to break even, how many shirts will you have to sell each day? Let’s assume your store is open six days a week, or 312 days per year. You would need to sell 2.13 t-shirts per day, calculated as follows:

667 ÷ 312 = 2.13, or three shirts per day rounded up

For your t-shirt company to make a profit, 667 t-shirts must be sold per year. The income from these 667 t-shirts will cover the costs of making them, and the sale of the 668th shirt will result in a profit. As a small business owner, try to keep your fixed costs down. The higher the fixed costs, the higher your break-even level of sales will be and the harder you’ll have to hustle!

Share this post: