A break-even analysis is used to calculate a break-even point. The term, break-even, means the point at which a product’s sales volume generates neither a profit nor a loss. That is, sales are just sufficient to break even.

But I’m here to make a profit, not to break-even!

When small business managers are introduced to the break-even point analysis for the first time, the notion of simply breaking-even sounds rather strange. After all, just about every small business aims to produce a profit.

In fact, a break-even analysis is not about purposely trying to break-even. Rather, its intended purpose is to calculate how many units (individual product sales) the business must make before it begins to generate a profit.

Prudent business managers calculate a break-even point, using several different scenarios. This allows them to identify and select the most attractive price points. It also helps them recognise those, which are considered to be un-viable.

It’s helpful to think of the break-even point as the starting line where profitability begins. Every unit sale beyond this point increases the product line’s overall profitability. Let’s now take a look at the break-even point formula.

The break-even point calculation formula

Learning how to conduct a break-even analysis is surprisingly easy. The break-even analysis formula consists of the firm’s average monthly fixed operating costs, divided by the gross profit per unit (i.e. measured in dollars).

The first step in the formula requires the price-setter to confirm their fixed operating costs.

Fixed operating costs are expenses associated with running the business. They’re called fixed, because they remain in-place irrespective of whether the business is open or closed. Rent, equipment leases, insurance and salaries are merely three examples.

Note: If management are wanting to conduct a totally accurate break-even point analysis, variable costs should also be accounted for. However, this makes the task more complex, because variable costs change depending upon output. Examples of variable costs include: labour and product packaging, which generally increase as production rises, and decline as production decreases.

To calculate our gross profit, we’ll need to subtract our product’s purchase price (cost price) from the price at which we will be selling the good or service. In accounting terms, the selling price is labelled, cost of goods sold (COGS).

A break-even analysis example

Let’s presume we own a gourmet sandwich shop. In this example, we’ll assume that our fixed operating costs are $8,000 per month.

Next, on average, let’s say the cost to produce one sandwich equals $2.00. In this example, we’ll also say that the average retail price — or COGS — (per sandwich) is $10.00. By subtracting the cost price from the retail price, we find ourselves making $8.00 gross profit, per sandwich, as shown below:

$10.00 – $2.00 = $8.00 gross profit per sandwich

Lastly, to complete our break-even analysis, we need to divide our fixed operating costs by our gross profit per sale ($8,000 divided by $8.00), and we’ll see that we need to sell 1,000 sandwiches each month just to cover our costs, and to, therefore, break-even.

Here’s what the calculation formula looks like:

$10.00 – $2.00 = $8.00
$8,000 / $8.00 = 1,000 sandwiches

Our break-even point calculator

We really hope you’ve enjoyed learning how to calculate a break-even point. Of course, we’ve supplied a free Excel-based break-even calculator for you to download.