Your break-even point is the threshold at which you start making money, once you've covered both your overhead expenses such as rent, and variable costs such as materials and labor. Knowing how many units you need to produce to reach your break-even point helps you plan and set goals to keep your company solvent. The accounting calculations may seem dry, but they represent an important and relevant milestone, marking the line between incurring a loss and earning a profit.
Variable costs are expenses that vary and more or less correlate with the amount of product your company produces. If you manufacture bicycles, you use twice as many tire and brake parts to make 40 bicycles as you do to make 20. It takes more labor as well to manufacture the additional units. Variable cost per unit usually doesn't change appreciably relative to how many units you produce.
Your contribution margin reflects the other costs that go into producing the items you sell. The overall amount you pay for these fixed costs doesn't change significantly relative to how much you produce. If you pay $1,000 per month in rent, you owe this amount to your landlord whether you produce one unit or one thousand units over the course of the month. Other fixed costs figured into your contribution margin include licenses, utilities and the expense of paying your bookkeeper. To calculate your contribution margin per unit, subtract your variable expenses per unit from your sale price. For example, if you sell a bicycle for $200 and it takes $150 worth of materials to build it, the remaining $50 represents your contribution margin. This sum will go towards paying your rent, bookkeeper and other fixed expenses until these costs are fully covered. After they are covered, the extra $50 becomes profit and you get to keep it.
To calculate your break even point in units, divide your total fixed costs by your contribution margin per unit. If your bicycle shop spends $3000 per month on rent, utilities, licenses and other necessary fixed costs, and your contribution margin is $50 per bicycle, you must produce 60 bicycles to earn that extra $3000. Your break even point is 60 units per month.
Desired Profit in Units
Once you've determined your break even point in units, you can proceed to calculate how many units you must produce and sell to earn a profit that will meet your personal and professional needs. Divide your desired profit by your contribution margin, which is now going directly towards extra income. If you hope to earn a $2,000 per month profit, you must produce and sell an additional 40 bicycles at a contribution margin of $50 per bicycle to earn this extra $2,000.
- If your break-even point prevents you from seeing the profit you desire, find less-expensive vendors, eliminate employees or reduce their hours, consider working out of your home and/or raise the price of your goods.
- Use a break-even analysis as a tool to forecast projected sales revenue when creating a business plan for a new venture.
Devra Gartenstein founded her first food business in 1987. In 2013 she transformed her most recent venture, a farmers market concession and catering company, into a worker-owned cooperative. She does one-on-one mentoring and consulting focused on entrepreneurship and practical business skills.