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Doing a break even analysis is important, because it clarifies when your business can expect to start making a profit. Here’s how to calculate your break even point.
What is break even? It’s when your running costs equal your generated revenues.
Breaking even means your business has neither made nor lost money. But when you do break even, you can expect to start making a profit.
As part of your forecasts and calculations when starting a business or launching a new product, it’s useful to do a break even analysis.
Doing a break even analysis is important. Otherwise you won’t be able to make effective decisions, or set a reasonable price point.
For example, if sales slow down and you don’t know your break even point, it’ll be more difficult to spot that your business will soon have trouble generating profits.
But knowing your break even point will help you work out how to remedy the situation, for example by cutting costs or raising prices.
You need to know a few figures to work out your business’s break even point:
Armed with those numbers, you can then use this break even formula:
Break even point = fixed costs / (average price - variable costs)
These costs stay the same, no matter how much you sell.
They’re usually related to a time period, for example a monthly rent payment or a weekly salary for your staff.
If you have high fixed costs, then you’ll need to sell more to break even. But if you can keep fixed costs low, you should be able to navigate periods of sluggish sales more easily.
Fixed costs include:
Variable costs change depending on how much you sell.
A clear example is the material used when building products, but other costs can be both fixed and variable.
For example, full-time staff are usually paid the same each month, according to their contract. But if they need to work overtime to deliver a product or service, any extra pay is a variable cost.
The nature of variable costs make them difficult to calculate, so it’s important to keep track of them accurately.
To work out total variable costs, focus on how much it costs to make one unit, then multiply that by total units produced:
Total variable cost = total units produced x variable cost per unit of output
Variable costs include:
A break even graph helps you visualise how long you’ll be making a loss for, your break even point, and eventual profitability.
If you’re wondering how to draw a break even chart, it’s fairly simple once you’ve worked out your costs and know your price.
The horizontal (X) axis shows your output in units while the vertical (Y) axis shows your costs and revenue.
You plot a straight horizontal line of fixed costs across the graph, as these don’t change with the number of units produced.
Then you plot a line for variable costs, starting at the point fixed costs start. This line represents total costs.
So if total variable costs for 600 units are £2,000, mark that point on the graph and draw a line upwards starting from the fixed costs line on the Y axis.
Finally you plot a line for total revenue. You need to multiply the price by the total number of units – if you’re planning on selling 600 units at £7.50, total revenue will be £4,500. Mark that point on the graph and draw a line from 0 on the Y axis upwards.
Where the two lines cross is your break even point.
In this example:
There are advantages to break even analysis, as well as some disadvantages. Break even can help you:
But as with any chart that looks into the future, there are limitations of break even analysis.
Try not to make your calculations unrealistic. Plus, make sure you keep on top of variable costs. As mentioned earlier, they can change often, which quickly makes break even analysis inaccurate.
Break even also predicts that you’ll sell a set number of your product or service at the same price. So you'll need to update your analysis as your business’s situation changes.
When was the last time you did a break even analysis and calculated your break even point? Let us know if this article was helpful in the comments below.
Sam has more than 10 years of experience in writing for financial services. He specialises in illuminating complicated topics, from IR35 to ISAs, and identifying emerging trends that audiences want to know about. Sam spent five years at Simply Business, where he was Senior Copywriter.
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