Break Even Analysis Formula made Simple
The break even analysis formula will show you how much revenue you will need in order to make zero profit. This is important because often times early stage businesses will spend more than they make which results in a loss. Operating at a loss may not be a bad thing, but understanding what it would take to actually not lose money is important.
Why do you need to make Zero Profit?…
This formula is often used in the planning stages of a business because many investors or stakeholders will check how difficult they think it will be to make zero profit. For example if your break even sales is 100k per month and the entire market is only 500k per month then the business may not be worth the effort.
Fixed Costs Fixed, Variable Costs Variable… Huh?
The formula itself would be very simple if all your costs were either fixed or variable. Fixed costs generally stay the same over time and variable costs generally change with output. For example the cost of office rent would be a fixed monthly cost but pay per click advertisements on google would be a variable cost.
If your business only has fixed costs then your formula is simple:
Break Even Sales Revenue = Total Fixed Costs
For example if you have the following expenses:
$1,500 monthly office rent
$3,500 monthly office admin salary
$150 monthly phone bill
$300 monthly utility bill
Your total expenses would be $5,450 (all fixed costs). That means that your total revenue would need to be $5,450 in order to break even.
Likewise if you only have variable costs then your formula would be super simple. As long as your sales price matches your variable cost per unit then you would break even as long as you have at least one sale.
For example let’s say you are selling computers online part time and somehow magically have no fixed costs. Your variable costs might look like this:
$150 Cost to buy each computer
$50 Cost to ship each computer to your house
$50 Cost to pay your little brother to assemble and repackage each computer
$50 Cost to ship each computer to your customer’s home
Your total variable cost would be $300 per computer. Therefore if you sell a computer for $300 then you would break even with just one sale. Consequently you would also break even if you sold 1000 units.
But realistically having no fixed costs is almost impossible.
How to Calculate Break Even Point
The full formula takes into account both variable and fixed costs and looks like this:
Break Even Sales Revenue = (Variable Cost Per Unit X Total Number of Units) + Total Fixed Costs
Sales revenue is equal to the Sales Price Per Unit X Number of Units. Therefore if you want to know the total number of units required to break even then your formula would be like this:
Break Even Units = Total Fixed Costs ÷ (Sales Price Per Unit – Variable Cost Per Unit)
Pulling your hair already? Don’t worry we will cover a big example very soon. But first let’s get a good definition.
What is the Break Even Point Definition?
The break even point is simply when your profit is zero. The point can be shown as a total revenue amount but should also include a sales price per unit and number of units.
So if I said that my ecommerce business would break even with 500 units sold per month then you might ask what revenue that would be. If I sold my units at $10 each then that would represent $5,000 in revenue per month right?
So why don’t I just say that I would break even with $5,000 of revenue? If you only have one product sold at one price then this would be fine, but most businesses have more than one product and more than one price. Therefore it is always best to explain the break even point with price per unit and number of units included.
Big Example of the Break Even Formula in Action
For this to really make sense lets look at an example. Let’s say you are selling toilet paper on amazon for $5 per pack (not sure how reasonable that is). Your credit card statement might look something like this:
- $35 amazon sellers fee
- $230 monthly salary for a part-time employee
- $199 for a mini course on how to sell on amazon
- $299 for a logo design
- $120 for shipping several samples from different suppliers
You also have the following information:
Quotation from supplier to buy 500 packs of toilet paper at $0.75 per pack.
Quotation from a shipping company to ship 500 packs of toilet paper for a total of $50 to amazon
Amazon fee of $1.50 per pack
Total Fixed Costs in this Example
Before we calculate any break even point let’s talk about one more type of cost, one-time cost. These are a type of fixed cost but usually they occur very rarely or just one time. In the above example, The mini course, logo design, and shipping of samples could be classified as a one time cost.
Therefore in order to put these into our break even formula we would have to create a time frame to look at and divide the monthly cost. Instead lets just ignore them for now and then we can add them back in later.
So total fixed costs are $230 + $35 = $265 per month
Total Variable Costs in this Example
The total variable costs are not yet paid but we know them from the quotations we have. $0.75 for our cost of goods + 0.10 for shipping ($50/500) + $1.50 for amazon = $2.35 of cost per pack.
For the sake of simplicity we are also ignoring economies of scale. Economies of scale is just the idea that we could get a cheaper cost per unit if we order larger quantities.
Finally, How do we Calculate the Break Even Point
Ok so our profit per pack sold is $5.00 – $2.35 = $2.65
So how many times do we need to make a profit of $2.65 in one month in order to pay our fixed costs of $265? (I made the maths nice and pretty) $265/ 2.65 = 100
What does this mean? It means that if we sell 100 packs then we would make zero profit per month.
Too Easy? Let’s Make it a Little More Complicated
Remember those one time costs? Well lets put them back in and say that we are going to be in business with just toilet paper for one year. In other words after one year we will need another mini course, another logo, and more samples.
So lets beef up that fixed cost number:
$265 + (199 + 299 + 120)/12 = $316.50 per month
New break even point (no more pretty maths):
$316.50/2.65 = 120 (rounded up because we can’t sell part of a pack)
So now to cover our start up costs we would need to sell at least 120 packs per month for one year at $5 per pack.
Confused with Break Even Point Formula and Break Even Analysis Formula Wording?
The break even point formula is the same as the break even analysis formula. Its just a terminology difference. Analysis usually means that more words and explanations should follow, while the point formula might mean just the numbers. These two phases are often interchangeable.
Conclusion and Why You Should Care
So all of this fun math is good but why should you care about it? Well lets look back at the example we have and find out what a savvy entrepreneur like you would do with this information.
We know that you need to sell 120 packs of toilet paper for $5 per pack every month to make zero profit. So what would it take for you to sell 120 packs? With some market research you can see how well others are selling on amazon and if they are selling more or less than 120 packs.
If so, then why would someone buy from you? What else would you need to do in order to sell 120 packs? If you need to buy advertising or create a softer toilet paper then you know that you will need to sell more than 120 packs to make it profitable.
Knowing your break even number gives you a starting point. It shows you what it would take to make this business a success. From there you can test if this is a viable business and understand how much risk is involved before actually starting the business.
- Source: © ra2 studio / Dollar Photo Club