The Importance of Breakeven Point for Business Owners

Apr 2, 2021
4 minute read

A small business owner can sell a huge amount of the best product imaginable. Still, without a solid understanding of the importance of accounting, that won’t ensure that your business will make a profit.

To be profitable, it’s important to have a business plan and a strong understanding of the total costs of your products versus the price of your product. A breakeven analysis is a key tool small business owners can use to break even and ensure their business’s profitability.

What is a breakeven analysis?

A breakeven point is a point at which the total cost and total revenue are equal. Basically, it’s the point at which the sales amount that’s required to cover a business’s costs has been reached.

A breakeven analysis is a calculation that allows small business owners to figure out what quantity of the product must be sold to generate profitability and help entrepreneurs come up with a pricing strategy that will not only cover costs but will ensure a gross profit.

How to conduct a breakeven analysis

To conduct an accurate breakeven analysis and identify your business’s breakeven point per product or service, it’s crucial to include all your business and your products’ costs. The formula for a breakeven analysis is as follows:

Breakeven quantity of sales = Fixed costs/(Sales price per unit – Variable cost per unit)

Let’s break that down a little bit.

Types of costs

It’s essential to keep your fixed and variable costs in mind when calculating a breakeven point. A small business owner must know their total fixed costs, as well as their variable costs, in order to calculate their cost per unit produced.

Fixed costs

Fixed costs are the types of costs that have to be paid each month, regardless of other factors like production output. Rent or employee salaries could be two examples of fixed costs.

Variable costs

Variable costs depend on how much output is produced. Which is to say, if you create more of a product, the variable cost will go up, and vice versa. Labour and raw materials may be two examples of variable costs.

Types of breakeven calculations

It can be helpful to calculate your breakeven point based on:

  • Quantity of sales: how many units will I have to sell to reach the breakeven point?
  • Sales price per unit: how will changing the sales price per unit affect my breakeven point? 
  • Variable costs: how will changing my variable costs per unit affect my breakeven point? 
  • Fixed costs: how will changing my overall fixed costs affect my breakeven point?

Let’s look at an example to see these kinds of analyses in practice.

Example of a breakeven analysis

Imagine an entrepreneurial child’s lemonade stand, with a fixed cost of $10 a month in rent, which they pay to their parents. They can sell each unit of lemonade for $1, and the variable cost per unit is $.10 for lemonade ingredients.

Calculation of breakeven point by unit

How many glasses of lemonade will they need to sell per month to remain profitable?

Fixed costs/(Sales price per unit – Variable cost per unit) = Breakeven quantity of sales

10/(1-.1) = Breakeven quantity of sales

Breakeven quantity of sales = 11.11

Using the breakeven analysis formula, we can see the lemonade stand will need to sell a little over 11 glasses of lemonade, or the number of units, a month to reach its breakeven point, and at least 12 glasses of lemonade a month to make a gross profit.

Calculation of breakeven point by sales price per unit

But, should the child increase their price per unit? While this will depend on a variety of market conditions, breakeven analysis can also come in handy here.

Remember our trusty formulas:

Fixed costs/(Sales price per unit – Variable cost per unit) = Breakeven quantity of sales

Say we want the breakeven quantity of sales to be 10, and not 11.

10/(Sales price per unit – .1) = 10

Sales price per unit = 1.1

In this case, if the child wanted to reach their breakeven point only selling 10 glasses of lemonade a month, without changing any other variables, they would need to raise their prices to charge $1.10 per glass of lemonade.

Calculation of breakeven point by fixed costs

Say the child’s business is booming, and they want to hire their little sister to help at a fixed salary of $1 a month. How will this affect the breakeven point? How many glasses of lemonade will the child have to sell at $1 each to break even?

Fixed costs/(Sales price per unit – Variable cost per unit) = Breakeven quantity of sales

The child’s fixed cost is now $11 instead of $10.

11/(1- .1) = Breakeven quantity of sales

Breakeven quantity of sales = 12.22

If the child’s fixed costs increase by $1/month, and they choose not to change their selling price, then the child will need to sell just over 12 glasses of lemonade a month to break even, and 13 to make a gross profit.

Calculation of breakeven point by variable costs per unit

Now say there is a lemon shortage, and the variable cost per unit increases to $.50. How many glasses of lemonade will the child need to sell now to reach their breakeven point?

Fixed costs/(Sales price per unit – Variable cost per unit) = Breakeven quantity of sales

10/(1-.5) = Breakeven quantity of sales

Breakeven quantity of sales = 20

If the variable cost per unit increases to $.50, the child will have to sell 20 glasses of lemonade a month to break even and at least 21 to make a gross profit.

How to use a breakeven analysis to make business decisions

As we can see from the examples above, there are many ways in which a breakeven analysis can help an entrepreneur to make important business decisions. You can use breakeven analysis to figure out how any number of variables in cost, price, and quantity sold can impact your business’s profitability.

Cost calculation

A breakeven analysis can help you to decide if your business will remain profitable if you increase your company’s fixed costs—if you choose to move to a bigger and more expensive office space, for instance, or hire another salaried employee.

Budgeting and setting targets

A breakeven analysis can also help you budget by giving you a sense of what your profitability will look like in an upcoming month, quarter, or year.

Motivational tool

A breakeven analysis can help you to set sales benchmarks for yourself and employees and motivate you to work harder when you know that your profitability is at stake.

Margin of safety

A margin of safety is the difference between the amount of expected profitability and the breakeven point. By comparing the breakeven point with the expected profitability you can easily flag when sales aren’t on track to be profitable and make you money.

Keep in mind that this information may change over time with market conditions, and it’s worth regularly conducting breakeven analysis of all of your products and services.

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This article offers general information only, is current as of the date of publication, and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by RBC Ventures Inc. or its affiliates.

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