How to perform a break-even analysis and how to use it
You can run this financial analysis at any time, but it’s most useful before you launch a new product. That’s because it’s a good indicator of whether your product or service idea—and greater business strategy—make long-term sense.
Learn how to calculate your break-even point using the formulas below, understand how much you’ll need to sell before your startup can sustain itself, and discover other practical ways to use a break-even analysis to further your business strategy.
What is the break-even point?
The break-even point (BEP) is when your total sales revenue is equal to your total costs.
In other words, it’s the exciting moment when your products are generating enough money to pay for your business expenses. If you earn revenue after this point, your business is making a profit. Below this point, your business is operating at a loss.
BEP can be measured in two ways. You can calculate how much you’ll need to earn in dollars (e.g., $10,000 per month for two years). Or, calculate the number of units you’ll have to sell (e.g., 750 watches per month for three years). In addition, you can find the BEP for a single product or for everything your business will offer.
Use a break-even analysis to answers questions like:
- Am I pricing my product(s) correctly?
- Is this service worth adding to my business right now?
- Can my operations support my target sales volume?
- Will my marketing strategy drive the level of sales I need?
- When will I be able to draw a salary (without adding to losses)?
- Which product will contribute the most to my bottom line?
But, you’ll have to crunch a few numbers before you can perform a break-even analysis.
4 numbers you need to run a break-even analysis
At the end of the day, the break-even point is an optimistic estimate. It’s built on thorough market research, competitor analysis, and realistic projections. This is true whether you’re determining the feasibility of a current product or a future one.
First, calculate the four metrics below. Then, we’ll show you how to plug them into the break-even formula with an example.
1. Sales price per unit
Sales price per unit, or revenue per unit, is how much a business charges its customers for a product. In the product screening stage, this is the price at which you expect to sell the item. If your business is up and running, you already know your unit selling price.
It’s alright if your price level is an approximation or has varied widely over time. In fact, it’s expected. One of the main reasons to perform a break-even analysis is to double-check your unit price and find the margin of safety.
The margin of safety is the difference between your sales and your break-even point. In other words, it’s your wiggle room—how many sales dollars you can lose before your business is no longer profitable.
2. Fixed costs
Fixed costs, also known as overhead costs, are business expenses that don’t change significantly from month to month. An expense is also considered a fixed cost if you pay for it even when you don’t make or sell any products.
While some of these costs are recurring, others are one-off purchases, like some of your business startup costs. Here are some common examples of fixed costs:
- Rent or mortgage
- Office supplies
- Insurance payments
- Loan interest payments
- Business license fees
- Marketing ads
Add up total fixed costs for the time period you’re measuring. Consider tacking on an extra percentage. That way, your analysis accounts for unforeseen expenses that could delay when you’ll break even.
3. Variable cost per unit
The variable cost per unit is how much you’ll pay to produce one specific product or service. You can also think of this as the cost of goods sold (COGS). Generally, the more units you sell, the more you’ll pay.
Use this variable cost per unit formula to estimate your costs:
Variable cost per unit = total variable costs ÷ number of units
If you haven’t launched the product yet, use quotes from potential suppliers, manufacturers, and third-party logistics companies. Here are some common examples of variable costs:
- Raw materials
- Direct labor costs
- Factory overhead
- Vehicle expenses
- Shipping costs
- Sales commissions
- Credit card processing fees
4. Contribution margin per unit
Contribution margin tells you how much a product contributes to your business revenue. It’s the difference between the sales price and the variable cost of a product.
You already have what you need to use the contribution margin per unit formula:
Contribution margin per unit = sales price per unit – variable cost per unit
If an item’s contribution margin is low (or negative), it’s not making much of an impact on the amount of revenue you earn. Your business might even lose money producing it.
(Some companies price below-cost on purpose to attract customers. This is central to the loss leader strategy, which is banned in some U.S. states. As an example, some grocery stores designate staple items like eggs and milk as loss leaders. They place them at the back of the store, in the hopes that buyers will grab profitable items on their way there.)
It’s also helpful to examine this figure as a percentage. Use this formula:
Contribution margin ratio = contribution margin per unit ÷ sales price per unit
Now that you’ve collected these business metrics, you can quickly calculate your break-even point.
The two break-even point formulas
A break-even analysis helps entrepreneurs make small adjustments to their pricing strategy, or pivot to a new idea completely. Ultimately, it answers two questions: When will my sales equal my costs, and what are some ways I can get there?
How to calculate your break-even point in units
This formula tells you how many units of a product you need to sell in order to break even. (Note: This metric is also called “break-even volume.”)
Break-even volume in units = fixed costs ÷ contribution margin per unit
Let’s use an example. Alice wants to launch a startup called H2Go that sells biodegradable water bottles for $14 each. She plans to pay $2,500 in fixed costs each month. She estimates it will cost $8.50 to manufacture and ship each bottle. That means the bottles’ projected contribution margin per unit is $5.50.
Break-even volume in units = $2,500 ÷ $5.50
Break-even volume in units = 454.54 bottles per month
Alice needs to sell roughly 455 water bottles each month to reach H2Go’s break-even point.
How to calculate your break-even point in dollars
This formula puts a dollar amount on your break-even point. You’ll need to use a different break-even formula to calculate this number.
Break-even point in dollars = sales price per unit × break-even point in units
Returning to our example, Alice plans to sell her water bottles for $14 each. She already knows her break-even volume is 455 water bottles per month.
Break-even point in dollars = $14 x 455
Break-even point in dollars = $6,370 per month
Alice’s team needs to sell at least $6,370 in water bottles each month to cover overhead costs.
Tips to break even, even faster
When you review your break-even analysis, you may discover that you have a wider margin of safety than expected. The news may not be encouraging. Perhaps you realize you’ll have to price your new service 30% higher than your competitors to break even in your timeframe.
There are many levers your business can pull to lower production costs and raise revenues. Here are a few tactics:
Raise your current or projected product prices
You don’t want to price yourself out of the market. But a modest adjustment could get you back on your timeline. And, your product or service may be more elastic than you think. Although you may not have the price advantage, you can position your business as a high-value alternative.
Lower your overhead costs
Shop around regularly for better manufacturing and material rates. Look for companies who provide tiered discounts based on your level of production. If labor and material costs are inflexible, you may have to rule a product out. Rent is also one of the largest business expenses. Calculate how much office space you really need and avoid overly expensive subleases.
Implement an effective marketing plan
If you can make more consumers aware of your business, you're one step closer to breaking even. Implement a compelling small business marketing strategy to raise sales. Marketing analytics tools let you track and adjust ad spend on every channel. You can reference our ecommerce marketing guide for online businesses to learn how to market more effectively.
Other helpful financial reports and formulas
Break-even point is an important sales target in the early days of a new business. And it’s just one of the metrics you’ll have to prove your business plan if you need startup funding.
A business plan being reviewed by lenders should also include the following financial projections.
- A pro forma profit and loss statement
- Estimated net working capital
- Estimated startup costs
- A cash flow projection
If you’re pitching your business to investors, be sure to highlight these key performance indicators in your pitch deck.
Break-even analysis: A necessary step
Risk is inherent to starting a business or introducing a product. You’re investing time, money, and energy into an idea without knowing how the market will respond. A break-even analysis lets you add some predictability to the equation.
Use the break-even point formulas to determine whether you’ve set a price that’s sustainable. You may need to get better control over your fixed costs, or go back to the drawing board all together. If you aren’t on track to break even in your timeframe, don’t worry.
Refer to the tips in this article, make adjustments, and then plug your new variables back into the formulas. This simple math saves you a lot of stress, whether your business is starting up or established.