What is a break-even analysis?

A break-even analysis calculates when a business, project or specific product becomes profitable. It determines how many sales a company needs to make to pay for its operating costs—or the costs associated with a specific effort or line.

Businesses can perform a break-even analysis using different price points or costs to forecast how various scenarios might impact profitability.

Why is a break-even analysis important to business owners?

Break-even analysis helps business owners understand when to expect a profit, which is essential in developing a strategy for covering costs or accelerating growth.

If your break-even point is too far in the future or requires a high number of sales, you might need to adjust your business plan to support sustainability. Business owners can use break-even analysis to set goals based on fixed and projected costs, giving them an idea of their company’s realistic gross profits.

A break-even analysis collects information regarding various expenses and income streams to help you determine how much you can pay yourself or reinvest into the company. It also provides insight into how your business makes money, helping you set ideal price points to maximize profits or identify opportunities to cut costs if necessary.

Related: 10 Steps to Starting a Business

What impacts the break-even point?

All forms of business revenue and expenses influence your break-even point. During a break-even analysis, you count your fixed and variable costs over a defined period. Then, you calculate how much you need to sell to cover those costs.

Income

While you need to understand sales, non-sales income is also a factor. Some examples of non-sales income that can lower your break-even point include:

• Savings account interest, dividends on investments and any other savings-related passive income your business accounts generate

• Fees paid to your business that aren’t directly related to sales, such as licensing fees for intellectual property

• Rents paid to your business if you sublet any part of your company property

• Late fees or other income generated from invoicing or another business process

Costs

Costs can fluctuate over time, but a break-even analysis requires an informed prediction about spending. Review past expenses or collect quotes for an accurate forecast. Common costs that can impact your break-even point are:

• Materials: Raw materials, supplies and inventory required to make your product or run your business

• Rent: Rent you pay for the use of buildings, property or equipment necessary to manage your company

• Labor costs: Wages and compensation paid to your employees and contractors

• Advertising: Marketing and advertising costs, including online advertising fees

• Recruitment: The cost required to find and hire the right team members

• Processing fees: Fees paid for shipping, handling, legal processing or other business-related matters

• Insurance: The cost of business and property insurance for your company

• Debt payments: Payments you make on property mortgages, credit cards, business loans and other company debt

How to calculate the break-even point

The following steps explain how to do a break-even analysis.

1. Categorize your costs

The break-even formula requires an understanding of fixed and variable costs. Fixed costs are business expenses that stay the same regardless of sales, such as rent. Variable costs, such as the cost of raw materials for making your products, directly relate to how much you sell.

Determine which category each cost falls into. It may help to make a two-column list and brainstorm with your accounting manager or leadership team.

2. Select a logical time frame

Determining accurate costs requires picking a time frame for your analysis. The fixed and variable costs you find over a year are likely to differ from those identified over a single month. You also have to consider how time can impact cost. For example, seasonal product lines may have higher costs during certain months.

Choose a time frame that provides an accurate picture of average costs. For example, if your business has an annual cycle, a year’s worth of data is helpful when conducting these analyses.

3. Decide on a price

To calculate your break-even point, set a price point for your products. If you use a break-even analysis to choose the most viable price for your inventory, select multiple prices and run a break-even analysis on each to see how changes could impact when you break even.

Raising prices could decrease sales, and lowering them could increase sales. It’s important to conduct market research when determining a reasonable starting price for your products and services.

4. Use the formula

Once you understand costs and potential pricing, plug your data into the break-even formula. The formula for the break-even point is:

Break-even point = Fixed costs ÷ (Item price – Variable costs)

For example, Happy Heart Smoothies sells breakfast drinks and wants to know how many units it has to sell at $7 per item to break even. Its main costs are:

• $2.50 per serving for ingredients

• $0.50 per serving for packaging

• $200 per month for website maintenance

• $500 per month on advertising

• $5,000 per month for employee wages

To calculate the break-even point, add up its fixed costs (website, advertising and labor costs) and divide that by profit per item (price per bottle minus the cost to make each bottle). The formula would look like this:

Break-even point = ($200 + $500 + $5,000) ÷ ($7 – ($2.5 + $0.50))

This simplifies to 5,700 divided by four, or about 1,425 breakfast smoothies per month (about 48 smoothies per day).

5. Reverse engineer the formula

Get more out of the break-even analysis formula by rearranging it to suit your business needs. For example, if you have a limited inventory and want to make your money back selling it, you can adjust the formula to calculate how much you need to charge instead of how many units you need to sell:

Price = (Fixed costs ÷ Item quantity) + Variable costs

Using break-even analysis to grow your business

Once you perform a break-even analysis, use that data to gain insights into your business and reach the point of profitability faster.

Assess your profitability

Run a break-even analysis in the beginning stages of your company to determine whether you can make a profit using your current business plan. If a business runs a break-even analysis and discovers it has to sell 5,000 units per month to break even, it can determine whether those sales goals are possible in the current market. Compare the break-even analysis to your market research, and adjust your sales techniques or pricing accordingly.

Find out where you make money

Perform a break-even analysis on each product or service to identify which drives the bulk of your business. Focus advertising on products with high enough margins to help you break even with fewer sales, or emphasize bulk orders of cheaper products if those are what your market buys.

Test different prices

Calculate multiple break-even points with different prices. You may be able to sell more products at a lower price or charge a premium to make up for lower demand and fewer sales. Setting an appropriate and competitive price ensures you can reasonably cover overhead costs.

Plan for the future

Once you break even, the next goal is to make a profit. Regularly perform new break-even analyses to reflect growth in your business and plan for funding future business expansion. A break-even analysis is a data-driven way to make decisions about business strategy and sales goals, and it can give you an idea of when to invest profits back into the business.

FAQs about break-even analysis

What are some types of break-even analysis?

By changing the break-even analysis formula, you can calculate how many units you must sell to break even on costs or how much revenue you need to generate to break even.

Can you have a break-even analysis for a project?

You can limit your break-even analysis to a specific project or product. For example, if a business owner creates a software app, they might be curious about how many monthly subscription sales will drive a return.

What is the best way to understand business costs?

The best way to gather accurate cost data to ensure better break-even analyses is to look at your financial records. If you use accounting software to track these costs, you can print reports for various periods to better understand cost trends. However, if your business is new and you don’t have these types of records yet, collect all invoices, bills and receipts for at least a month so you can start with a baseline understanding of costs.