Our ‘Understanding Accountancy Terms’ blog series deals with all of those frequently asked accounting and finance questions. In this article we explain what the term break even point means for your business, and how and why to carry out break even analysis.
What is a Break Even Point (BEP?)
In very simple terms, the breakeven point is the moment where your business has made enough money to recover costs. So when people talk about breaking even, they mean the point at which the total cost and the total revenue are balanced. The breakeven point (or BEP) is the fine line between profit and loss.
Why perform a BEP analysis?
Calculating the breakeven point will tell you how many sales are needed before the business can expect to start making a profit. That’s essential data when it comes to business planning!
A business that makes a lot of money might still fail if it’s not actually making enough to break even, let alone make a profit.
How do I calculate my breakeven point?
To work out your breakeven point, you’ll need to know:
Fixed costs: these are the regular payments that won’t change, even if output does – for example, rent or insurance.
Variable costs: the costs that change in proportion to your sales (for example the cost of making or buying your product or service).
The price per unit: what you’re selling that product or service for.
Fixed costs ÷ (price – variable costs) = breakeven point
Subtract your variable costs from the price. Divide your fixed costs by that answer. That’s your breakeven point.
What does a high or low breakeven point mean?
A low breakeven point means that the business will start making a profit sooner, whereas a high breakeven point means more products or services need to be sold to reach that point.
So, if your breakeven analysis reveals a high breakeven point, then you might want to consider:
If any costs can be reduced
If the sale price could be increased without causing a drop in sales
Product variants, such as making tweaks to the product or service so that it appeals to a wider audience (without significantly increasing cost)
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Variable costs and your breakeven point
Looking at ways of reducing costs is a delicate process. After all, you don’t want to damage the quality of your product, or leave staff feeling stressed! Your fixed costs, things like insurance, or assets such as machinery and building, tend to stay just that – fixed. That said, moving to smaller premises or a cheaper location can lower these.
Variable costs will change depending on the level of sales. For example, if you experience high demand, you’ll consider buying more stock, or taking on staff to provide more of your service. Doing that might mean taking on more staff, buying more raw materials, paying for more water and power, and so on.
As the costs increase, so too will your breakeven point – make sure that you don’t find yourself selling more units, but not making any money.