What Is The Break-Even Point: Formula and Calculation

Starting a new business is both exciting and demanding. Regardless of your industry or business model, one question stands out: When will you reach your break-even point?

Determining your break-even point is a core part of any business strategy. It clarifies your fixed and variable costs, allowing you to set prices effectively and estimate when your business will begin generating profit.

It ultimately helps with pricing, cost control, and financial planning. 

In the following sections, we explain what is the break-even point, how to calculate it, and more. 

What Is The Break-Even Point In Business?  

The break-even point (BEP) is the moment when a business’s revenue equals its costs over a defined period. At this point, the business is not making a profit, but it’s not losing money either. Every sale beyond break-even contributes directly to profit.

Else said – the break-even point shows the minimum sales volume needed to cover all expenses.

To identify your break-even point, you’ll need to perform a cost analysis where you carefully inspect all of your expenses, including fixed and variable.

Needless to say, the BEP is fundamental for business planning, pricing strategies, and investment decisions. For card payment businesses and retailers accepting card payments, the break-even point usually operates at the transaction level, not just monthly or yearly revenue.  

Key Components Of The Break-Even Analysis  

The break-even analysis isn’t complicated, as long as you’re aware of all the key components:

• Fixed costs;
• Variable costs;
• Contribution margin;
• Cost structure.

Here’s what you need to know about each. 

Fixed Costs  

Fixed costs are the business expenses that remain relatively constant over time and don’t change or only go through slight changes. 

For most companies, fixed costs include:

• Rent; 
• Maintenance costs; 
• Insurance and accounting;
• Licence fees;
• Utilities, like electricity, water, and internet;
• Depreciation; 
• Software subscription; 
• Insurance.

Your production or sales volume won’t affect these costs. 

Variable Costs  

Variable costs are exactly the opposite of fixed costs – they vary depending on your production volume or the sales you generate. 

Variable costs usually include:

• Labour costs; 
• Raw material costs;
• Advertising spend;
• Packaging;
• Shipping costs;
• Electricity (for running equipment for longer hours); 
• Transaction fees. 

All of these expenses fluctuate and are directly related to manufacturing your products. It’s important to note that in most cases, variable costs are the biggest expense for businesses.

Contribution Margin  

The contribution margin is the sales price per unit minus variable cost per unit. Simply put, it demonstrates how much each unit contributes to covering fixed expenses and accumulating profit. 

Let’s say a handbag’s selling price is £100, while its variable costs for production are £20. In this case, the contribution margin will be £80.

The £80 is then utilised to pay for the fixed costs, and in the case that there are any financial resources available after that, this is the net profit. 

Cost Structure  

Cost structure shows how a company’s total costs are divided between fixed and variable expenses. Understanding where the balance between these two types of costs lies can significantly influence flexibility and risk. 

It’s crucial that you understand this mix as part of your break-even analysis, as it will directly affect the speed at which you can reach your break-even point. 

For example, a company with a fixed-cost-heavy cost structure has substantial expenses, no matter how many units it sells. This usually leads to a higher break-even point as enough contribution margin must be generated to cover these costs before making a profit.

In contrast, a variable-cost-heavy cost structure is one where costs rise directly with sales volume, leading to a lower break-even point. 

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The Break-Even Point Formula  

If you want to calculate the break-even point in units, use the following formula:

Fixed Costs ÷ (Sales Price Per Unit – Variable Costs Per Unit)

Fixed costs are the constant expenses that you accumulate, no matter what the production output is. 

Sales price per unit represents the amount a business will charge its consumers for a single product, where the product is the one for which the calculation is being done. 

Finally, variable costs are the expenses that change with the product production. 

Example: How To Calculate Break-Even Point Step-by-Step  

Let’s take a real-life example.

Imagine you’re running a barefoot shoe brand and you’re thinking of launching a new product and want to know how it will affect your finances. This information will help you figure out whether this will be a good investment. 

Let’s say your fixed costs are £10,000 for the month, while variable costs per unit are £60 and the selling price per unit is £100. Using the formula from above, we’ll divide £10,000 by  (£100 – £60) to get 250. 

In other words, you’ll need to sell 250 units to cover all your costs. 

Break-Even Point In Financial Planning And Strategy  

While the break-even point is key for understanding when revenue covers costs, it can be helpful in many different ways as part of your business strategy. 

Here’s how it can inform business decisions: 

• Pricing decisions - by understanding the contribution margin per product or transaction, companies can assess whether prices are high enough to cover fixed and variable costs, or whether price adjustments are needed to reach profitability faster.
  
• Investment decisions - break-even analysis shows how long it will take for new investments to pay for themselves. A higher fixed-cost investment may raise the break-even point in the short term, but could reduce variable costs and improve profitability over time.
  
• Product and service development - before launching a new product or service, break-even analysis helps estimate the sales volume required to justify development costs, allowing businesses to prioritise offerings with realistic paths to profitability.

Break-even point can also be linked to revenue targets and profit goals. It offers a clear baseline for revenue planning and allows business owners to set minimum sales targets, define profit margin goals, and model different scenarios.

In the UK, break-even analysis is also key when seeking bank loans, private investments, or venture capital and angel funding. Investors and lenders expect to see when a business plans to break even and how sensitive that point is to changes in costs or revenue.  

Using Break-Even Analysis For Cost-Volume-Profit (CVP) Insights  

Break-even analysis is often the starting point for understanding business profitability, but cost-volume-profit (CVP) analysis takes this thinking a step further. It expands on the break-even concept by examining how changes in sales volume, costs, and pricing interact to affect overall profit.

A key element of the cost-volume-profit analysis is the relationship between contribution margin and marginal cost - the cost of producing or processing one additional unit or transaction. 

When the contribution margin exceeds marginal cost, increasing volume contributes positively to profit. When it does not, higher volume can actually increase losses.

CVP analysis also incorporates price elasticity, allowing businesses to model how price changes influence demand and profitability. 

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Sensitivity Analysis: Testing “What If” Scenarios  

But what about changes in cost, price, or demand? How will they affect your break-even point?

Sensitivity analysis is a technique used in financial modelling to test how changes in such variables affect the break-even point. By adjusting one assumption at a time, businesses can see how sensitive profitability is to external or internal changes.

With spreadsheets or financial modeling tools, companies can quickly test scenarios - such as rising input costs, price changes, or lower sales - and see how the break-even point shifts. This helps identify which variables pose the greatest risk to profitability.

For UK companies, sensitivity analysis is particularly valuable when preparing for inflation, supplier price increases, or changing market conditions. 

For those relying on merchant account services, sensitivity analysis is especially important. Even small changes in transaction fees, settlement costs, or pricing structures can significantly shift the break-even point.

Interpreting The Break-Even Point For Business Decisions 

Overall, the break-even point helps determine business viability and sustainability. It’s a key asset to help assess the profitability threshold for new products, services, or even locations.

By incorporating it into your strategic forecasting and performance dashboards, you can make informed decisions and always be one step ahead. It’s also a powerful instrument that can help fuel better cost management.

Limitations Of Break-Even Analysis  

There are a few limitations of the break-even analysis that businesses must be aware of.

The drawbacks of the break-even analysis are that it:

• Assumes costs are linear and constant;
• Doesn’t account for external market changes, like demand shifts and inflation; 
• Ignores qualitative factors like brand value, market demand or customer loyalty;
• Should be complemented with broader financial indicators and market research.  

As long as you’re aware of these limitations, you can use this analysis to your advantage without risks. 

Practical Tips To Lower The Break-Even Point  

The good news is that, regardless of your business type, there are practical ways to lower your break-even point.

For example, you can try:

• Reducing fixed costs by outsourcing or investing in automation;  
• Improving contribution margin by increasing prices or lowering variable costs;  
• Enhancing sales efficiency using mobile card payments or digital invoicing;  
• Streamlining cost management with accurate data tracking and forecasting.  

The most appropriate approach to lowering the break-even point will ultimately depend on your business and processes. 

Conclusion  

Using the break-even analysis to determine your break-even point is a must for all businesses in the UK and throughout the world. 

The BEP helps support sound financial planning, risk management, and pricing strategies. As a UK business, it’s highly recommended that you review your break-even point as part of a broader financial modelling and performance analysis. 

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