Break Even Point Formula: A comprehensive guide for SMEs

As a business owner, understanding your company's break even point is an important step in planning for future growth and new projects.

The break even point marks the point at which your company begins to be profitable, with income overtaking the fixed costs of running your business.

Using break even point analysis to determine how your company will need to perform in terms of sales to achieve a profit can help you assess the viability of a product idea, as well as fine tune your costs and sales price to ensure your business is successful. This guide walks through the basics of the break even point formula and how to incorporate it in your business decision-making process.

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What is the break-even point for a business?

In short, the break even point is the point at which the income your business generates exceeds the fixed costs of running it.

Fixed costs are those which apply regardless of how much goods or services you sell, such as the cost of hiring a store or office, utilities, insurance or equipment hire. By working out the break even point you can see how many units of product or hours of billed time, or how many dollars in total sales you would need to achieve to cover your fixed costs and start to turn a net profit.

Understanding the break even point can help you figure out if your business - or a specific new product you’re thinking of launching for example - is going to become profitable quickly enough to be worthwhile.

If the break even point is too high, you may consider options to change this, such as:

• Increasing your sales prices or
• Cutting your variable costs to achieve break even point more quickly.

How to calculate break-even point

You can calculate break even points in two different ways: based on the value of your sales in dollars, or based on volume of units sold.

To calculate the break even point based on units sold you would use the following break even formula:

This can be a simple way to calculate your break even point if you sell only one product which has uniform pricing, but it’s not so helpful if you have a product range with variable prices and variable costs associated.

The alternative formula can be more helpful in this case, as it looks at overall sales value rather than unit numbers.

To calculate the break even point based on sales dollars you would use the following break even formula:

In which:

Contribution Margin = (Price of Product – Variable Costs)/Price of Product

Break even point example

Let’s take a look at how you might use the break even point formula to decide whether or not to launch a new service or product line.

In this example you’re considering launching an IT consulting business.

• You know you will incur fixed costs of 5,000 SGD a month for office space, equipment, licenses and so on.
• You expect to charge clients 100 SGD an hour for services, and
• It’ll cost you 50 SGD an hour to hire a contractor.

Using the first break even formula, you’d calculate your break even point as follows:

5,000 SGD/(100 SGD - 50 SGD) = 100

where you would need to bill 100 hours of work in a month to reach break even point.

Using the second approach, the figures look like this:

5,000 SGD/0.5 = 10,000

where you would need to generate 10,000 SGD in income over the course of the month to cover your costs and begin to be profitable.

These analytical approaches can be helpful when deciding whether or not to expand a business, add a new product line or open a new venture entirely.

If the break even point doesn’t seem achievable or desirable, you can then start to look at options to change this, such as reducing your variable costs.

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Why is knowing your break-even point important for SMEs?

Knowing your likely break even point before you start a new project can help you:

• Determine your selling prices, and
• Help you decide if the fixed or variable costs associated with your business idea are feasible.

If you’re not going to become profitable quickly enough for your personal needs, you might decide to increase the sales prices of your items, or look for ways to reduce your costs in manufacturing or service.

Knowing when you’re going to be able to generate a profit from your business - either in terms of the number of items you must sell or the total sales volume you need to achieve can be a useful step in your business planning. Used along with other analysis tools, calculating break even point is valuable for businesses of any type or size.

Why break-even point is not all about cutting costs

If you’ve calculated your break even point and want to optimise it, the good news is that there are several different ways for an SME to reach break-even point - it’s not always about cutting costs.

• If you want to make your break even point more achievable you might consider increasing your sales prices - as long as this won’t price you out of the market entirely.
• Or, you might decide to improve the efficiency of your operation, effectively cutting out some of the variable costs involved in things like labour.

By looking at all of the different levers you can pull to change the financial performance of your business you’ll be able to balance the impact of different measures to find the right one or combination for your specific business needs.

Pros and cons of using break even point

Using the break even point method isn’t the only option available to you when planning for your business. It’s a useful approach, but will often be used alongside other analysis tools to get a nuanced view of what needs to be done for your business to be more successful. Here are a few of the pros and cons of the break even point method for you to consider:

You can use break even point calculations in your business when:

• Setting sales targets,
• Deciding on a pricing strategy,
• Setting cost management controls,
• Evaluating investments and
• Launching new products or services.

Understanding your break even point allows you to change some of the business factors which influence break even targets, to optimise your business, increasing sales prices or reducing your costs for example.

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