Calculating the break even point is one of the most important concepts that business owners, entrepreneurs, and general managers can understand. This is because the break even point is when you transition from operating at a loss and actually start making a profit, which is the goal of every business.
The very first question to ask is what are we trying to sell? A service, a product, or a mix of products and services? For this example we will be assuming a very simple product offering. We are going to imagine that we are opening up a coffee shop that only sells lattes. You will likely have a mix of products and services that you will want to analyze. If your cost accounting is accurate, then you should be able to determine the break even point for each product and service you offer.
After we have figured out what we are going to sell (i.e. lattes), we must then identify the following variables:
- How much are we going to sell our product/service for?
- What are our fixed costs?
- What are our variable costs?
Fixed costs are those costs that we have to pay to run our business, regardless of the number of units we sell. In the example of the coffee shop we could expect to have the following fixed costs:
- $500 / Year
- Admin Staff Salary
- $20,000 / Year
- Total Fixed Costs
These are the costs associated with making a single product. For example, to make a Latte we might expect the following variable costs:
- Espresso Beans
- $0.20 / Cup
- $0.10 / Cup
- Cup & Lid
- $0.15 / Cup
- $0.25 / Cup
- Total Variable Costs
- $0.70 / Cup
Calculating the Break Even Quantity
Bq = FC / (P – VC)
Bq = $32,500 / ($4 – $0.70)
Bq = 9,848 Lattes/ Year
Profit = $0
So I have to sell more than 9,848 lattes in order to make a profit. If I sell any less than that, I will be paying money to keep the doors of my coffee shop open. A few years of that and eventually I will shut the coffee shop down.
Anything above that point and I will be putting some cash in my back pocket.
If you found this post helpful, please share on LinkedIn or Twitter.
Thank you for reading.