Knowing your breakeven point is useful – often invaluable – when budgeting or forecasting your business finances. The breakeven point tells you how many sales you need to make in a given period before the business makes a profit.
Breakeven is the point your business arrives at, in any given financial period, when it makes neither a profit or loss. To build a sustainable business, you need to make sure it breaks even in the long run – it must make profits (or at least not make losses). That is why understanding the break even sales quantity is valuable.
How do we work out the breakeven point? There are a few things you need to determine:
- The sale price of one unit of product/ service
- The variable cost per unit of product/ service (those costs that vary according to the number of units produced and sold)
- The sum of all the business’s fixed costs (those costs that do not vary according to the number of units sold) in the period under review
Armed with this information, you can start to work out how many sales you need to make to break even. Here's the formula:
Break even quantity = fixed costs / (sale price per unit – variable cost per unit)
Deducting the variable cost per unit from the sales price per unit gives us a figure known as the “contribution margin” - the amount in £ which each sale contributes towards your business's fixed costs.
Let’s take a simple example. ABC Ltd has budgeted for fixed costs of £50,000 for the next financial year. It sells its product, alphabet soup, at £1 per tin (it’s really, really good soup!). The variable costs associated with producing each tin total £0.50. To cover its fixed costs and break even in the next financial year, it needs to sell £50,000 / (£1.00 - £0.50) = 100,000 tins.
Clearly the picture becomes more complicated where the business sells more than one product or service, each with a different contribution margin. The principals remain the same though – you just run the calculations using an appropriate “mix” of products, and you can also then see what impact different proportions of different sales categories have on the overall breakeven point.