{"id":8174,"date":"2024-10-31T13:42:09","date_gmt":"2024-10-31T19:42:09","guid":{"rendered":"https:\/\/www.blockadvisors.com\/resource-center\/?p=8174"},"modified":"2024-11-03T14:37:47","modified_gmt":"2024-11-03T20:37:47","slug":"break-even-point","status":"publish","type":"post","link":"https:\/\/www.blockadvisors.com\/resource-center\/finance\/break-even-point\/","title":{"rendered":"Understanding break even point (BEP): Definition, formula, and examples"},"content":{"rendered":"\n

Have you ever wondered how small businesses stay afloat, let alone turn a profit? A critical topic that explores this concept is called “break even point,” or “BEP.” Never heard of this? Don’t worry \u2013 understanding this financial term is not as complex as it sounds! Follow along as we break down the specifics, with definitions and clarity on how to calculate break even point.<\/em><\/p>\n\n\n\n

<\/a>What is break even point?<\/h2>\n\n\n
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\"A<\/figure>\n<\/div>\n\n\n

Imagine you want to start a baking business. You\u2019ve got all the bakeware, supplies, ingredients, an industrial kitchen lease, and even hired some help. Now, the big question: How many cakes do you need to sell to cover these initial expenses and start making a profit?<\/em><\/p>\n\n\n\n

This is where the break even point comes into play. It\u2019s the seemingly magical point that lets you, as a small business owner, know when you have reached profitability. More specifically, it finds the exact moment a business’s revenue equals its total costs. When you look at how many sales of a product or service will take to hit the break even point, any additional revenue after that point is generally profit. Knowing your break even point can also help you understand the impact of investments you may make for your company. Understanding when an expense is worth it may help with pricing strategies, allocating resources, and setting goals.<\/p>\n\n\n\n

<\/a>How to find the break even point<\/h2>\n\n\n\n

Your company will reach the break even point when the cost of running your business equals the sum of business revenue generated over a specific time period. In other words, it\u2019s the point at which your business is neither making money nor losing it. Keep reading for an example if you’re wondering the purpose of this metric and exactly how to calculate break even point. <\/p>\n\n\n\n

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<\/a>What is the purpose of a break even analysis?<\/h2>\n\n\n\n

Doing a break even point analysis helps you learn about your business\u2019s financial performance and ensures you\u2019re financially secure. Think of the analysis as a compass guiding your business\u2019 trajectory.<\/p>\n\n\n\n

More specifically, it can help:<\/p>\n\n\n\n

1. Set business goals: <\/strong>Knowing the break even point gives you a tangible, concrete goal to work towards. For example, if your goal is to achieve profitability by year three, you can weigh that goal against the break even point given your current expenses and revenues. This clarity can help set the tone for your business plan and strategy, motivating you to increase sales, change pricing strategy, cut costs, or take other actions to reach your goals – or even develop a different timeline for goal realization. <\/p>\n\n\n\n

2. Set pricing:<\/strong> A break even analysis is a secret weapon in pricing products or services. It helps you understand the minimum price to charge to avoid losses. For example, if it costs you $10 to bake a cake and you need to sell 15 cakes daily to break even, charging less than $10 is not a good move. Conversely, once you understand and exceed the BEP, you can experiment with pricing. Charging more can increase your profit margin \u2013 leaving more profit to invest back into growing your business. Keep in mind, though, that increasing prices may also reduce demand. It’s all a balancing act. <\/p>\n\n\n\n

3. Allocate resources:<\/strong> When you know your break even point, you can determine how much money to invest in marketing, production, and expansion while not overspending.<\/p>\n\n\n\n

4.<\/strong> Reveal all expenses:<\/strong> Uncover expenses you might not have seen coming in your budget<\/a>. Conducting a break even analysis can help you account for both recurring and one-time expenses to minimize surprises down the line. A good break even analysis will consider the impact of variable and fixed expenses on your bottom line. <\/p>\n\n\n\n

5. Limits subjectivity: <\/strong>A break even analysis can objectively help you make business decisions by focusing on the facts and hard numbers of your business. It can reduce the sway of emotions on key business decision.<\/p>\n\n\n\n

6<\/strong>. Secure funding:<\/strong> It\u2019s often used as a proof point when attempting secure financing. Your break even analysis shows potential investors your business\u2019s viability for investment and gives them confidence that you understand every aspect of your business expenses and revenue-producing activities.<\/p>\n\n\n\n

<\/a>How to calculate break even point<\/h2>\n\n\n\n

Before we show you the break even point formulas<\/em>, let\u2019s cover some complementary terms to help you better understand the formula. Understanding fixed costs, variable costs, and contribution margin will streamline learning about break even point.<\/p>\n\n\n\n

What is fixed cost?<\/strong> These expenses stay the same no matter what. Rent, insurance, and salaries for permanent staff are examples of fixed costs.<\/p>\n\n\n\n

What is variable cost?<\/strong> These expenses vary depending on the quantity of products or services sold. Materials, subcontracted or hired labor (if you pay per cake made), and packaging costs fall into this category.<\/p>\n\n\n\n

What is contribution margin?<\/em><\/strong> Contribution margin is the amount of money remaining after subtracting variable costs from your total revenue. This margin usually covers the company\u2019s fixed costs. If your business is service-based, you will likely have a lower contribution margin. If your business has higher fixed expenses (oftentimes seen with product-based companies), you may have a higher contribution margin. <\/p>\n\n\n\n

The profit of a single product or service. It\u2019s calculated with the following formula:<\/p>\n\n\n\n

Contribution Margin = (Revenue – Variable Costs)<\/p>\n\n\n\n

Contribution Margin Ratio = (Revenue – Variable Costs) \/ Revenue<\/p>\n\n\n\n

Now that we\u2019ve covered these definitions let\u2019s use one of two formulas.<\/p>\n\n\n\n

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  1. The break even point formula in sales dollars:<\/strong> Break Even Point ($) = Fixed costs \/ Contribution margin<\/li>\n\n\n\n
  2. The break even point formula in number of units:<\/strong> Break Even Point (units) = Fixed costs\/ (Sales price per unit – Total variable costs per unit)<\/li>\n<\/ol>\n\n\n\n

    Both formulas above determines the break even point. But one will give you the BEP in dollars and the other in units.<\/p>\n\n\n\n

    <\/a>1. Calculating break even point in sales dollars<\/h3>\n\n\n\n

    If you\u2019re wondering how to find<\/em> the break even point in sales dollars<\/em>, here is the formula again as a reminder: <\/p>\n\n\n\n

    Break-even point ($) = Fixed costs \u00f7 Contribution margin ratio<\/em><\/strong><\/p>\n\n\n\n

    Let’s look at an example: Callie\u2019s Cakes is a cupcake company based in the Chicago area. She is considering introducing a new product called “Cake Poppers.” She wants to know how this potential new line will impact the company\u2019s profitability. Her small business bookkeeper walks her through the break even point calculation. Her findings help her determine whether this new product is worth launching.<\/em><\/p>\n\n\n\n

    First, we’ll outline the fixed cost, variable cost, and sales price for the defined time period in consideration. For the first month the product will be in production, Callie\u2019s Cakes “Cake Poppers” costs are estimated to be as follows:<\/p>\n\n\n\n