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A break even analysis is used to figure out how much product your business needs to sell to cover its costs of doing business. It can also be used to figure out when your business will begin to make a profit. If you are just starting out, you can use a break even analysis to figure out if your business idea is worth pursuing.
So how does this work? Your company has broken even when its sales equal its total expenses. At the break even point, you’ve made no profit but you also haven’t incurred any losses. A break even analysis lets you know how many units of things—phones, tables, or hours of legal service—you need to sell to cover your costs. Every product you sell generates a cost—because products or services are made up of cost of materials or cost of wages. Thus, the more you sell the more your expenses will be. If you gross $1000 in product sales in one month, that amount will NOT cover $1000 in monthly overhead expenses. Why? Because out of a $1000 gross profit, a certain amount of that may be the wholesale price. When you deduct the wholesale price from $1000 you may end up with only $500 in gross profit. The break even point is when the revenue equals ALL business costs, wholesale and overhead included.
How do you calculate a break even point? With the Break even Analysis Model, of course! You will need to know 3 key things:
After you have those numbers, use this equation to find your break even point:
Break Even Point = Fixed Costs/ (Sales Price Per Unit – Variable Costs)
This gives you the number of units you need to sell to cover your costs per month. Anything you sell above this number is profit. Anything below this number means your business is losing money.
Once you’re above the break even point, every additional unit you sell increases the profit by the amount of the unit contribution margin. The unit contribution margin is the amount each unit contributes to paying off fixed costs and increasing profits. So:
Unit Contribution Margin = Sales Price Per Unit – Variable Costs
You can use the break even formula to compare different pricing strategies. For example, if you raise the price of a product, you’d have to sell fewer items but it might be harder to attract buyers. Or vice versa: you can lower the price, but would then need to sell more of a product to break even.
This analysis can also help you compare different cost structures like using less expensive materials to keep the cost down, or taking out a longer-term loan to have less fixed costs per month.
If it costs $50 to make a TV, and you have fixed costs of $1000, the number of TVs you must sell to break even would be:
If you sell a TV at $100: $1000/($100-$50) = 20 TVs
If you sell a TV at $200: $1000/($200-$50) = 6.7 TVs.
This demonstrates that if you sell the product for a higher price the break even point will occur significantly faster.
Ready to get started on your own break even analysis? Then we invite you download our free break even analysis template here. Good luck!