How to Calculate Your Break-Even Point and How to Use It
Posted: Tuesday, May 16, 2006
by Bob Normand
Institute for Smart Business Management
Definition of Break-Even:
The Break-Even point in sales volume is defined as:
“ That point in sales volume, or revenue, where direct costs have been recovered, fixed overhead expenses have been absorbed and where profit begins".
We can relate Break-Even Point to the information in our financial statements, particularly the Income Statement. The Income Statement should be organized into the following sections:
The sum of all sales and other income net of returns and sales commissions.
2. Cost of Sales (Cost of Goods Sold)
The cost of purchases that are resold (merchandise) and/or raw materials plus the costs of labor to manufacture the product or convert it or install it or deliver it or construct it on site. These costs are also called direct or variable costs.
3. General & Administrative Costs (Overhead)
These are all the costs not directly, or easily, related to sales volume such as Advertising, Bank Charges, Computer Expenses, Insurance, Office Wages & Salaries, Officer’s Compensation, Telephone, Utilities, Depreciation, Interest, Taxes etc. These costs are also called indirect or fixed costs.
4. 1 minus 2 minus 3 = PROFIT.
Note: If your Income Statement is not organized in this fashion (called managerial accounting format), you need to have a session with your accountant and demand it be put into this format so you can manage the business better.
Once you have your financial statements and data in the right format, you can easily calculate Break-Even using the following formula as:
Break-Even Point = FC/(1-VC/S)
Where: FC = Fixed Costs
VC = Variable Costs
S = Sales
For illustrative purposes, let’s look at an example company, Acme Specialties, that has the following data from its Income Statement:
Sales = $1,000,000
Cost of Goods Sold = $710,000
General & Admin = $215,000
Acme’s Break-Even Point ( during the period indicated by the income statement) is:
Break-Even Point = FC/(1-VC/S) and
VC/S = 710,000/1,000,000 = .71
1- VC/S = 1 - .71 = .29
FC/(1-VC/S) = 215,000/.29 = $741,379 = BEP
And the company operated at $1,000,000/741,379 = 135% of Break-Even during the period.
Break-Even can be calculated for:
A Company
A Division
A Location
A Department
A Store
A Product
A Product Line
A Service
A Day
A Week
A Month
A Year (or any other time period)
This is assuming, of course, that fixed costs can be accurately or, at least, reasonably associated with the organizers above.
Using Break-Even in Modeling:
The Break-Even formula can be used as a model to estimate the effect of major decisions on the financial status of the business such as adding a new location, making a capital investment, dropping or adding a product line. Simply estimate the changes in fixed and variable costs (and sales) that result from the decision and plug them into the Break-Even formula for your company. This can also help you set goals for the new operation.
In fact, ANY significant contemplated change in your cost structure resulting from a proposed decision can be modeled to determine the effect on the company’s financial results before the decision is made. You will know what you face and are required to overcome ahead of time. You will be able to set goals based on financial facts rather than intuition only.
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Top-level comments on this article: (9 total)I want to know about roughly break even point. I'm learner accounting.
This article was very basic and informative
THIS ARTICLE WAS FABULOUS...NEVER TAKE IT OFF!
I really found it helpful course i am studying project management technology,so it has helped my understanding.Thanks alot.Olugbue frank chidi.
formula is good but it required application in marketing
This article was really super...One suggestion, if you try to give one an example problem means it will be of great helpful...But still it helped me a lot !!
By..
Gita..
awesone artucle i have to say, it saved me
This explaination is detailed.. but then i still cant do my question... Anyone know where does fixed overhead costs fall under? General and admin or COGS?
The term "Fixed Overhead Costs" and "General and Adminitrative Costs" are synonymous and refer to costs that do not change or change little with change in sales volume. COGS is the other side of this; they should be expected to change (usually proportionally) with sales volume. COGS are also known as "Variable Costs"
In the article COGS = Variable Costs = VC and G&A = Fixed Costs = FC.
I hope this helps.
Yes its not bad but I would like to have some more examples for contribution ratio
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