What Is Break-Even Analysis and How to Calculate It?

Whether you’re starting a business, pivoting your existing business in new directions, or even launching a new product — a break even analysis can be an important prerequisite; through break even analysis, it’s often possible to determine at what point something will become profitable.

This can be an essential part of mitigating risk and taking on viable ventures — but what is it? How does one calculate a break even point  — what is a financial break even point, and why is break even analysis so important in business? If you’re wondering how to find break even point, read on; that’s what we’ll be exploring in this piece. Let’s dive in.

Definition of Break Even Analysis

What information does a break even analysis provide for a firm? Simply put, a break even analysis is an analysis that seeks to identify the point in time at which something — often a business or new product launch — will begin to break even.

So, what is break even point? Breaking even simply refers to neither making a profit or a loss but recouping your costs. In other words, break even analysis looks at costs and revenue and attempts to pinpoint the time at which revenue will begin to meet costs. Before the break-even point, a product is creating a loss, and past the break even point, a product should be generating profit.

Why Use Break Even Analysis?

There are a number of reasons to perform a  break even analysis. This can be a part of a larger strategy to carry out due diligence, an important factor in creating a viable business model, and even a method through which those carrying out potentially risky ventures can work to assure stakeholders and investors.

Break-even analysis can help identify goals in business plans, such as the number of units that must be sold in a certain time period in order to break even, or — even better — make a profit. It can also be used to identify risks and weaknesses in a business plan  — such as an unrealistic goal upon which viable outcomes hinge.  

For example, if your break even analysis shows that you must sell 100 units per month in order to break even within five years, but historically the most units you’ve been able to sell in a month has been less than 50, the entire plan may be worth revisiting.

Finally, break even analysis can be used for pricing. By determining break even points, we can balance competitive pricing with viable pricing to determine a “sweet spot.”

How To Carry Break Even Analysis Out

Now that we’ve explored the importance of break even analysis and some of the cases in which one may be used, you may be wondering how break even analysis is carried out. Importantly, you’ll need to account for static costs, variable costs, and expected revenue.

Fixed Costs

Fixed costs are those which remain static over time, or those which are not subject to fluctuating. For example, rent, flat-rate utilities, and property taxes, which tend to stay stable over time, are often considered fixed costs.

Other potential fixed costs include insurance, loan payments, leases, or even warehouse security costs. These can often be predicted with a high degree of accuracy, making them helpful in predicting future costs. In contrast, variable costs can fluctuate dramatically due to factors such as sales, economic conditions, and changing personnel.

Variable Costs

Variable costs are those which change over time. These can include things such as personnel pay, which might vary depending on the number of employees you need, or shipping costs, which can vary depending on how many units you sell or how many supplies you buy. Other variable costs might include materials used for production, inventory carrying costs, packaging supplies, and utilities that aren’t flat rate.

Revenue

The final primary component of a break even analysis is revenue. Like variable costs, revenue is often subject to much change, so estimating revenue can be a complex process. Importantly, this may be predicted using a combination of data such as historical sales figures when applicable, and market research when there are no historical sales to analyze.

How to Calculate Break Even Point In Units

So, what is the break even point formula? In order to perform a break even analysis, we often begin by calculating how many units must be sold in order to break even. From here, we can perform further analysis to determine viable timeframes in which this many units must be sold. In order to calculate the number of units that likely must be sold in order to break even, the break even formula is rather simple.

The estimated break even point in units is typically equal to fixed costs divided by its contribution margin. The contribution margin is simply the total price per unit, minus variable cost per unit. This is what the formula might look like:

Break even point (in units) = fixed costs / (price per unit - variable cost per unit)

Estimating Timeframes

Once we have a break even point in units, we can estimate a timeframe by dividing our break even point in units by our monthly estimated sales. Then we can determine, if we’re able to sell a certain amount of units per month, the point in time at which we may break even. This can be an important part of the equation, especially for startups and other new ventures, who might expect to post losses for a certain amount of time.

Additional Considerations

What are the advantages and disadvantages of break even analysis? It’s worth noting that even the most robust break even analyses are inherently speculative in nature. In other words, while we can estimate variable costs, sales per month, and other factors necessary to determine break even points, these are generally all subject to change.

What’s more, external factors such as market conditions, competitors, and others can have a significant impact on businesses. A break even analysis also fails to consider the viability of one decision against another and instead focuses on the viability of one decision, relatively within a vacuum. Still, break even analysis is often a critical part of determining whether a decision is viable, and stands as an important tool for businesses of all kinds, from retail stores to wholesalers.

The Bottom Line

Break-even analysis is often an important part of doing business. They’re often used to gauge the viability of different ventures, and can be important in establishing actionable goals. What’s more, break even analysis can be used to determine fair pricing. There are a number of reasons to use a break even analysis, and it will be important to understand some of the factors we’ve discussed, such as fixed costs, variable costs, and revenue. In so doing, companies can position themselves for success, better enabling themselves to determine the viability of different decisions.

Remember, if you’re looking for ways to level up your inventory counting practices, Zupan can help. With robust software designed to make counting inventory easy, we’re here to support businesses of all types to better manage their inventory. To learn more, get in touch today.