Calculating and Using the Break-Even Point
by by Marty Schulz, Albany BizCenter

In business, there are a few key numbers that owners or managers will constantly monitor in order to keep their companies running smoothly. Sometimes managers will calculate the life-time value of a customer in order to keep a good perspective customer service, while others might monitor the profit and turn rate per inventory item in order to maximize their merchandising efforts. While each industry has their own unique set of key numbers to monitor, one of the most widely used key numbers is the break-even point. The break-even point helps managers to calculate how much additional revenue would be required to take on more expenses, such as buying additional equipment or adding more employees. It helps solve many business problems which involve costs and sales relationships. While break-even analysis shouldn't be used to solve all decisions having to do with sales and costs, it is a very good method for an initial analysis of a problem.

The break-even point is the level of sales at which a business neither makes a profit nor sustains a loss; the point at which the business has exactly enough income to cover expenses, with nothing left over.

The steps involved in calculating the break-even point are:

1. Compile a list of all business expenses.

2. Separate the list into variable and fixed expenses, then add them up. (Variable expenses change proportionately to a change in sales or production; fixed expenses do not change in proportion to sales or production.)

3. Subtract the per unit variable cost from the sales price to obtain a per unit contribution margin.

4. Divide fixed expenses by this contribution margin. This answer is the break-even point in unit sales.

Let's try an example. A feed store compiles a list of all business expenses and has found that they need $15,000 per month to cover the fixed costs of rent, salaries, insurance, etc. They also buy feed at a wholesale price of $1.50 per pound and sell it for $2.00 dollars per pound. To calculate the break even point, subtract the $1.50 per pound cost from the selling price of $2.00 dollars per pound and you'll get a 50 cent per pound gross profit margin. Divide the 50 cents per pound into the 15,000 monthly fixed costs, and the store will need to sell 30,000 pounds of feed each month to pay its expenses. That's an average of 1,000 pounds in sales per day!

What's interesting are the sales beyond the break even point. This is where profit occurs. With our feed store example, we had to sell $60,000 worth of feed in order to be able to pay all our bills but show no profit. Now, every single additional dollar of sales past this point, contributes 50 cents to profit. Where sales of 30,000 pounds of feed showed no profit, sales of 35,000 pounds shows a $2,500 profit.

Knowing that profit doesn't occur until after the break even point is reached highlights the power of achieving the break even point as early in the month as you can. The sooner you achieve this point, the sooner you start making profit. It also shows the importance of keeping your fixed costs down. The smaller your costs, the quicker you'll achieve break even.

Most business owners like knowing exactly what they need to generate each month and even each day to "break-even". Lastly, we all know that business owners love to buy new equipment and this analysis can be very helpful when deciding what new sales level will be necessary when we add costs to our operation.

Marty Schulz is a business counselor for the Albany BizCenter. The center exists to help local business owners achieve greater success.