The break-even point in a business is the level of sales or sales revenue that must be made before a company can cover its expenses and start to earn profits. In simple terms, this is a production level that helps understand how much to invest to achieve the desired return.
By calculating the break-even value, an organization can know whether they are profitable or not. So, if they are losing money, they will probably want to cut down on their selling prices to increase profitability. On the other hand, if they are already profitable, they might want to consider increasing their prices to generate additional sales revenue. Either way, conducting a break-even analysis will help a company decide what action to take next.
The break-even price is the amount of money needed to produce one item. This price includes both fixed and variable costs.
Fixed costs are those that remain constant regardless of quantity produced, such as rent, salaries, utilities, insurance, etc. Variable costs vary based on the quantity produced, including raw materials, labor, fuel, electricity, shipping, and advertising, among others.
The break-even price is calculated by determining the total cost of producing one unit. The variable costs are then subtracted to arrive at the break-even point. If the break-even point equals the current market price of the item being produced, then no additional investment is necessary. However, if the break-even point exceeds the market value, then additional investments must be made to increase sales volume.
In many cases, companies want to know whether or not it makes sense to start producing a product or service. They want to know what price they need to sell each unit to break even level. In other words, they want to know how much revenue is needed to cover the variable costs.
The break-even point is calculated by dividing fixed costs by the contribution margin from each sale. This calculation helps business leaders determine how many units they need to sell before they start making money.
Break-Even Point (units) = Fixed Costs / (Sales price per unit – Variable costs per unit)
This formula tells finance teams how much money they need to bring in to cover their production costs, regardless of how many units they produce. If they don’t reach the company’s break-even point, then they won’t be able to pay off their fixed costs.
The formula also works in reverse. By entering whatever the sales price per unit is, business executives can calculate their variable cost per unit to see the break-even quantity.