How to Calculate Your Breakeven Point

You need to keep this figure as low as possible. But do you know how to calculate the breakeven point when you sell multiple products? BY Ian Benoliel | May 27, 2002| 0 Tweet

Q: I understand how a one-product company calculates its breakeven point, but how is the
calculation done when you sell multiple products? My firm sells two products, chairs and bar stools, for $50 per unit. The variable costs are $25 for each chair and $20 for each bar stool. Fixed costs for the firm are $20,000 per month. If the sales mix is 1:1 (one chair sold for every bar stool sold), what is the breakeven point in dollars of sales and in units of chairs and bar stools?

A: In a previous article, I described this simple formula for calculating the breakeven point:
breakeven = fixed costs /gross margin percentage, where fixed costs are recurring monthly expenses that do not vary with sales (such as rent, salaries and so on) and gross margin percentage of a product means its profit divided by its price. That simple calculation assumed a one-product company; therefore, it was easy and straightforward to determine the gross margin of a particular product. However, the calculation gets a little more complex when you throw additional products into the mix. The answer to your question lies in the calculation for computing the gross margin for multiple products. The breakeven calculation itself does not change. Instead of using the simple gross margin percentage, you must compute the "weighted average" gross margin percentage, which is calculated as the sum of the gross margin percentage for each product multiplied by its percentage of sales. Returning to your example, the chair has a gross margin of 50 percent: (50-25) /50. The stool has a gross margin of 60 percent: (50-20) /50. Each product accounts for 50 percent of the unit sales of the firm (meaning a 1:1 sales mix). Therefore, the weighted average gross margin is:

Chair: 50% x 50% = 25% Stool: 60% x 50% = 30% Weighted average gross margin = 55% (25% + 30%)

Then, you would use the weighted average percentage in the breakeven formula as follows: breakeven = $20,000 /.55 = $36,363. To calculate the unit sales of each product, take the breakeven sales, multiply by the product's sales mix, and then divide by its price as follows:

Stools to sell = $36,363 x 50% /$50 = 363 stools Chairs to sell = $36,363 x 50% /$50 = 363 chairs

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Leading experts offer financial management advice in Bigwig Briefs: Become a CFO--The Real World Intelligence to Become a CFO or to Become a Better CFO or Financial Professional. From the above example, we can see how changing the sales mix can affect the breakeven point. For example, if the above firm were to sell 70 percent stools and 30 percent chairs, the breakeven point would be reduced to $35,088 because the weighted average gross margin increased to 57 percent. Conversely, if the firm where to sell 30 percent stools and 70 percent chairs, the breakeven point would be increased to $37,736 because the weighted average gross margin decreased to 53 percent. Your goal as a business owner is to keep the breakeven point as low as possible. Product price, product costs, product volume and fixed cost all play a role in determining the breakeven point as well as the ultimate success of any business. Ian Benoliel is the CEO of NumberCruncher.com Inc., a developer of budgeting, manufacturing and management software for entrepreneurial businesses. NumberCruncher combines its accounting and finance expertise with technological know-how to deliver software that is affordable and easy to use, yet sophisticated and powerful. More information on the NumberCruncher's products and services is available at www.numbercruncher.com. Ian has nearly two decades of business, accounting and financial consulting experience. He has advised corporations on business plans, financial projections and accounting computer systems. If you can accurately forecast your costs and sales, conducting a breakeven analysis is a matter of simple math. A company has broken even when its total sales or revenues equal its total expenses. At the breakeven point, no profit has been made, nor have any losses been incurred. This calculation is critical for any business owner, because the breakeven point is the lower limit of profit when determining margins. Defining Costs There are several types of costs to consider when conducting a breakeven analysis, so here's a refresher on the most relevant.

Fixed costs: These are costs that are the same regardless of how many items you sell. All start-up costs, such as rent, insurance and computers, are considered fixed costs since you have to make these outlays before you sell your first item. Variable costs: These are recurring costs that you absorb with each unit you sell. For example, if you were operating a greeting card store where you had to buy greeting cards from a stationary company for $1 each, then that dollar represents a variable cost. As your business and sales grow, you can begin appropriating labor and other items as variable costs if it makes sense for your industry.

Setting a Price This is critical to your breakeven analysis; you can't calculate likely revenues if you don't know what the unit price will be. Unit price refers to the amount you plan to charge customers to buy a single unit of your product.

Psychology of Pricing: Pricing can involve a complicated decision-making process on the part of the consumer, and there is plenty of research on the marketing and psychology of how consumers perceive price. Take the time to review articles on pricing strategy and the psychology of pricing before choosing how to price your product or service. Pricing Methods: There are several different schools of thought on how to treat price when conducting a breakeven analysis. It is a mix of quantitative and qualitative factors. If you've created a brand new, unique product, you should be able to charge a premium price, but if you're entering a competitive industry, you'll have to keep the price in line with the going rate or perhaps even offer a discount to get customers to switch to your company. One common strategy is "cost-based pricing", which calls for figuring out how much it will cost to produce one unit of an item and setting the price to that amount plus a predetermined profit margin. This approach is frowned upon since it allows competitors who can make the product for less than you to easily undercut you on price. Another method, referred to by David G. Bakken of Harris Interactive as "price-based costing" encourages business owners to "start with the price that consumers are willing to pay (when they have competitive alternatives) and whittle down costs to meet that price." That way if you encounter new competition, you can lower your price and still turn a profit. There are always different pricing methods that can be used.

The formula: Don't worry, it's fairly simple. To conduct your breakeven analysis, take your fixed costs, divided by your price, minus your variable costs. As an equation, this is defined as: Breakeven Point = Fixed Costs/(Unit Selling Price - Variable Costs) This calculation will let you know how many units of a product you'll need to sell to break even. Once you've reached that point, you've recovered all costs associated with producing your product (both variable and fixed). Above the breakeven point, every additional unit sold increases profit by the amount of the unit contribution margin, which is defined as the amount each unit contributes to covering fixed costs and increasing profits. As an equation, this is defined as: Unit Contribution Margin = Sales Price - Variable Costs Recording this information in a spreadsheet will allow you to easily make adjustments as costs change over time, as well as play with different price options and easily calculate the resulting breakeven point. You could use a program such as Excel's Goal Seek, if you wanted to give yourself a goal of a certain profit, say $1 million, and then work backwards to see how many units you would need to sell to hit that number. (This online tutorial will show you how to use Goal Seek.)

Calculators There are several online calculators to assist you with your breakeven analysis:

Case Western Reserve University offers a breakeven analysis calculator that includes a review of relevant microeconomic terms. This financial calculator allows you to chart your costs and profits appear in a graph. Inc.com offers a breakeven analysis calculator that requires a user to enter in total annual overhead and annual year-to-date sales and cost of sales, and lets the user delineate the period for the YTD calculations in terms of weeks.

Limitations It is important to understand what the results of your breakeven analysis are telling you. If, for example, the calculation reports that you would break even when you sold your 500th unit, decide whether this seems feasible. If you don't think you can sell 500 units within a reasonable period of time (dictated by your financial situation, patience and personal expectations), then this may not be the right business for you to go into. If you think 500 units is possible but would take a while, try lowering your price and calculating and analyzing the new breakeven point. Alternatively, take a look at your costs - both fixed and variable - and identify areas where you might be able to make cuts. Lastly, understand that breakeven analysis is not a predictor of demand, so if you go into market with the wrong product or the wrong price, it may be tough to ever hit the breakeven point.

Solving Break-Even Analysis Problems

The formula used to calculate a breakeven point (BEP) is based on the linear Cost-VolumeProfit (CVP) Model[1] which is a practical tool for simplified calculations and short-term projections. See reference [1] for more information about this model, and especially the discussion about the assumptions. All the different types of break-even analyses are based on the following basic equation:

Break-Even Equation
Total Costs = Total Revenue TC = TR

TFC + TVC = P X TFC + (V X) = P X The variables and definitions used in the break-even equation are listed below.

P = Selling Price per unit V = Variable Cost per unit. X = Number of Units Produced and Sold TR = Total Revenue = P * X TC = Total Costs = TFC + TVC TFC = Total Fixed Costs TVC = Total Variable Costs = V * X P-V = Contribution Margin per unit (CM) CMR = Contribution Margin Ratio = (P - V) / P

Payback Period
The Payback Period is the time it will take to break even on your investment. In break-even analyses in which are are solving for the break-even price or number of sales, the payback period is defined ahead of time. Depending on rate of change in your market, this may be a few months or a few years. Or, if you are just starting a business, your bank may want to see evidence that you will start making a profit after 18 months, or some other period.

Sales Price
One of the assumptions of the linear CVP model is that the Sales Price per unit (P) remains constant. So, the total revenue (TR) is just the price (P) multiplied by number of units sold (X). However, prices typically decrease with increasing demand, so be aware that the linear CVP model is a simplification.

Variable Costs
Variable costs include the production, direct labor, materials, and other expenses which depend on the number of units produced and sold. On financial statements, like an income statement, Cost of Goods Sold (COGS) is a variable cost. Some variable costs may be percentage-based (like commissions) while others may be dollar-based (like material costs). Example: If you are selling software online, the payment processing service might charge $1 plus 7.5% of the sale price. If the sale price was $14.00, then the Variable Cost per unit (V) would be 1+(0.075*P) = $2.05. In the break-even calculator, you can split the cost between the percentage-based and dollar-based categories.

Direct Labor: Let's say that every 100 sales requires 8 hours of technical support over the life of the products. If the labor cost (including payroll taxes) is $20/hr, then the Variable Cost per unit (V) would be V = (8*$20)/100 = $1.60 per unit. The linear CVP model assumes that the Variable Cost per Unit (V) is constant over the specified Period. You should be aware that this is a simplification. For example, when labor is involved in production, productivity can have a significant effect (see ref [1]).

Fixed Costs
Fixed costs are those which are assumed to be constant during the specified payback period and which do not depend on the number of units produced. Advertising, insurance, real estate taxes, rent, accounting fees, and supplies would all be examples of fixed costs. Fixed costs also include salaries and payroll taxes for non-direct labor such as administrative assistants and managers, or in other words, the payroll not included as variable costs. In reality, increasing production may also increase the expenses that are listed as "fixed costs" because they increase as the business grows and hires new employees. After you run the breakeven analysis, and especially if you use the CVP model to calculate sales required to reach a target profit, you should revisit your cost analysis to ensure that the costs match the level of production and sales required to reach your goals.

Break Even Chart

The spreadsheet includes a break-even chart like the one shown below, which shows the BreakEven Point (BEP) as the intersection between the Total Revenue and Total Cost when plotted with the number of units on the x-axis. The Profit (or Loss) is also shown on the chart as Total Revenue - Total Cost.

Formula to Calculate the Break-Even Point

You can find the basic breakeven point formula all over the place, and the formula that is most often given is for calculating the "Break Even Units", or the number of units that you'll have to sell to cover costs. Actually, there are many ways to define the break even point. You may want to solve for the total dollar sales to break even, what price you'll have to charge to break even. You may also want to calculate how long it will take you to break even, which is officially called the payback period.

Break-Even Units
The following formula is for calculating the number of units (X) you will have to sell over the specified period of time. X = TFC / ( P - V ) X = TFC / CM If you want to solve for the number of units required to reach a targeted Net Income Before Taxes (NIBT), then substitute (TFC+NIBT) for TFC in the above equation.

Break-Even Sales
The break-even sales amount (S) is just the total revenue (TR) at the break-even point, which can be calculated as S = X P. The following formula, derived from TR = X P is another way to calculate the break-even sales amount. S = TFC / ( 1 - V / P ) S = TFC / CMR The value (1 - V / P) is known as the Contribution Margin Ratio (CMR), which is basically just the percentage of revenue earned for each unit sale after subtracting out the variable costs: CMR = 1 - V / P = (P - V) / P

Break-Even Price
To solve for the price, you can use the Goal Seek tool in Excel to set X to a certain value by changing the price. The formula for solving for the break-even price requires you to break down the variable costs into dollar-based and percentage-based costs:

V = Vd + (Vp P) = Variable Costs per unit Vd = Total Dollar-Based costs per unit Vp P = Total Percentage-Based costs per unit

The following formula is used to solve for the sale price (P) required to break-even if you produce and sell X units during the specified payback period. P = ( 1/(1-Vp) ) ( Vd + (TFC / X) ) If you want to solve for the price required to reach a targeted net income before taxes (NIBT), then substitute (TFC + NIBT) for TFC in the above equation.

Payback Period
For very simple sales scenarios, the CPV model can be used to solve for the Payback Period, or the number of months required to break even. Like the other formulas, we start with TR = TC. Both the revenue and the costs may depend on time so we have to define a few new terms. To calculate the payback period, the number of units sold (X) is specified as a number of units per month. The fixed costs are broken down further into Start-up Costs (SC) and Recurring Fixed Costs (RC). Start-Up Costs are the costs required to develop the product, or create the very first product. Recurring Fixed Costs are those which are paid monthly or annually but which are not directly tied to the number of units sold, like web-hosting fees, monthly advertising expenses, insurance premiums, etc.

t = Payback Period in months TFC = SC + (RC t) TVC = V x t SC = Total Start-up Costs RC = Recurring Costs per month x = Number of units sold per month = X / t

Payback Period (t) = SC / ( Px - Vx - RC ) Break-Even Sales (S) = P x t Example: The selling price for an iPhone application is P=$1.99 and I expect to sell x=450 units per month. The development cost of the application is SC=$7,500 and my recurring monthly fees for advertising and web hosting come to RC=$65.00/month. I am charged a commission of Vp=30% to sell the app from iTunes. Result: The break-even spreadsheet calculates the payback period to be 13.35 months, which I'd round up to 14 months (because fractional recurring costs don't make sense in this case). Important: This calculation should only be used as a rough estimate. It does not take into account the time value of money, risk, interest, financing, opportunity costs, etc. The financial formulas NPV and IRR are usually better for calculating the return on an investment.

References and Resources

[1] Management Accounting: Concepts, Techniques & Controversial Issues by James R. Martin, Chapter 11.

Beak-Even Calculator at cwru.edu - A very good simple example from the Case Western Reserve University. Breakeven Analysis Explained at cpa.utk.edu Break-Even Period for Paying Points on a Mortgage at decisionaide.com - An interesting calculator I wish I had seen a while ago. Cost-Volume-Profit Analysis at wikipedia.com - Some nomenclature. How to Do a Breakeven Analysis at about.com

Reference this Page

To reference this page as an article about break-even analysis, or to share our break-even calculator spreadsheet, please link to this page using a citation similar to the following: - "Break Even Analysis" by Jon Wittwer at Vertex42.com.