Break-Even Point is the point where costs are equal to that of revenue. All of your pricing structure that you apply to your products depends upon the Break-even point calculation. Businesses need to determine the break-even point to know where they stand in terms of prices and profits.
No. of Units/Revenue = Variable Cost + Fixed Cost
Here’s What We’ll Cover:
- Calculation of Break-even point
- Example of Break-Even Point Analysis
- Profit earned following your break-even
- Break-Even Analysis
- Uses of Break-Even Point Analysis
Calculation of break-even point:
There are two basic formulas to calculate the break-even point:
- Units of Product sold:
Break-Even Point (Units) = Fixed Costs
(Revenue per Unit – Variable Cost per Unit)
Above is the break-even point based on units of product sold.
- Sales in Dollars:
Break-Even Point (sales dollars) = Fixed Costs
Above is the break-even point based on the sales done in dollars.
- Fixed costs do not vary, such as rent, utility bills, monthly expenses, etc.
- Variable costs vary in number and are not fixed, such as labor, the material used for production, etc.
- Contribution Margin (CM) is subtracting Variable costs from that of the price of the product. The formula is as follows:
Contribution Margin= Price of Product – Variable cost
It tells the difference between the price of the product and the cost of making the product.
Example of CM:
If you are selling a product for $200 and the cost of material used in production and labor is $100, then the Contribution Margin is equal to $100, which can cover the fixed cost, and if you still save some amount, then that would be your net profit earned.
Example of Break-Even Point Analysis:
We take an example of a Company ‘A’ that already has an established business but starts manufacturing a new product line of making candies. Company A wants to know if this new product line is beneficial for them or not? And are their plans realistic to achieve the profits? Is the pricing too high or too low?
Calculating the Break-even point can solve all these questions to know where Company A stands for its new product line.
The total costs used for production are the following:
Fixed Costs = $4000 (for the month)
Variable Costs = $0.8 (per candy produced)
Selling Price = $3 (per can)
- Break-Even Point in Units:
($3 – $0.8)
= 1,818 units
The Company A needs to sell over 1800 candies in order to achieve its break-even point in units.
- Break-Even Point in Sales (Dollar):
Contribution Margin= $3 – $0.8
= $2.2/ $3 =0.7333
B.E in sales= $4000
We can also calculate this amount by taking 1818 units from the above calculation and simply multiply it with a sales price of $3 and get the answer of $5,454.
To achieve this month’s break-even point, company A has to sell candies worth $5,454. Any amount left after this point of break-even will be the company’s net profit.
Profit earned following your break-even:
Once your sales equal your fixed and variable costs, you have reached the break-even point, and the company will report a net profit or loss of $0. Any sales beyond that point contribute to your net profit.
Break-even Analysis is a crucial part of every starting business, to know when the business starts generating profits. Break-even Analysis is where you find out fixed costs (rent, utility bills, etc.) and variable costs (material) to set the prices of products you sell. You calculate the units in the currency your business originates, which covers the material costs.
Uses of Break-Even Point Analysis:
In Businesses, you don’t just calculate the break-even point, and that’s it; the work here is done. No! That’s not the case; in fact, you may realize that you have to sell more of the products than you had estimated to break even.
This is the right point after doing all the calculations that are your goals and plans realistic? Is the current plan working for you? Do you need to cut your prices or costs? Are your prices too high or low?
You have to consider each and everything to sustain your business in the market and be successful. You have to also think about selling the amount you calculate for break-even because there is no guarantee that you will sell the same number you calculate. Things are not as easy to do as they seem to be.
Before starting a new business or introducing a new product like the company/investor should take the break-even analysis knowing the risk. The company/investor must be prepared for everything, including the risk factors, the selling process, etc.
Here are some points that might work for you while planning out things after doing the break-even analysis:
- Prices: after carrying out the calculations for the break-even point, you might know how you should set your prices. If the prices are too low, then set according to the production costs and compare the market’s set price, you would know if your price is okay and not too high.
- Costs: are the costs of material used in production along with labor too high? Then seek how to lower the cost without compromising the quality of your product.
- New Product: If you decide to launch a new product, keep in mind the fixed and variable costs. For an estimate, calculate both of the costs and have a look if it’s according to your range that you want to invest in it.
Conclusion: The Break-Even Analysis Defines the Long-Term Success of Your Ecommerce Business
Running the break-even analysis is not as complicated as it may first seem.
But calculating the BEP is only the first step of a series of decisions you have to take:
Is the number of units you have to sell to turn into the profit zone realistic? Will price elasticity effects hinder the successful launch of your product? Do you need to cut costs along your supply chain?
If you’re just starting out with your e-commerce business and have to manage a limited financial budget, knowing the BEP is crucial to assess and control your profits.
But also experienced business owners should pay close attention to the power behind the break-even analysis. As simple as it might seem, it can uncover hidden and expensive cost components along the supply and value chain of your business.