Break-even point: how not to work at a loss?

The break-even point is the volume of production or sales that covers all mandatory costs. With a further increase in sales volume, the project or business begins to operate at a profit.

The break-even point is calculated when drawing up business plans and investment projects, planning production volumes. In this article you will learn how to calculate the break-even point in monetary and physical terms, what initial data is required for the calculation. We will also look at the advantages and disadvantages of the break-even point method and practical examples.

What is the break-even point (profitability threshold)

When opening a new business or a new direction in business, any entrepreneur asks the question - how many products need to be sold in order for the activity to become profitable. This question is also relevant for an investor investing money in a business project.

Calculating the break-even point shows at what point the company stops incurring losses and begins to operate efficiently. This indicator can be calculated both in monetary and physical terms (the number of units of products produced, work performed or services rendered).

Another name for this indicator is profitability threshold. We remember that profitability is the ratio between expenses and profit received. So, the break-even point represents the very critical volume of production, upon reaching which the project becomes profitable.

In simple words, the break-even point determines the moment when the company no longer incurs losses, but does not yet make a profit.

What does the break-even point show?

The break-even point (a combination of its components) shows the reporting period at the end of which the company made a profit. Depending on the further dynamics of sales and the volume of production of goods, the company can increase profits, or, conversely, reduce them and thus fail to achieve the break-even point. That is, the break-even point is a dynamic indicator. But a successful enterprise, once achieved, usually stays there in the future.

The timing of reaching the break-even point of a business project is the most important indicator for an entrepreneur, investor, partner, and lender. Any of them expects to quickly reach the point when the business will begin to make a profit, and also expects that the company will further develop with positive dynamics in revenue and volume of goods produced, combined with optimal costs.

Why is it important?

So, at the break-even point, profit is zero. Therefore, at the initial stage of business, calculating the indicator is important to determine the minimum volume of revenue and the minimum price level.

At a certain stage of project development, the break-even point shows how changes in volume affect the price level and how to optimize costs.

Example. Equipment for the coffee shop was purchased in the amount of RUB 427,500. ($5,700 or 165,300 UAH). In order to recoup these costs, you need to sell 2850 cups of coffee costing 150 rubles. ($2 or 58 UAH). If the approximate number of visitors to a coffee shop is 100 people per day, then this is 15,000 rubles. ($200 or 5,800 UAH) per day. That is, it will take us about a month to pass the break-even point. If we want to recoup costs faster, we need to increase the cost of a cup of coffee. But won’t the number of visitors decrease if the price of coffee rises, say, by 38 rubles? ($0.50 or 15 UAH)? This depends on many factors, in particular the average price of a cup of coffee in similar types of coffee shops, as well as the presence of competitors nearby.

Such an analysis can be carried out only when the coffee shop has been operating for some time and there is an opportunity to evaluate the results of its activities.

Of course, this example is conditional, because The break-even point is determined taking into account other costs - fixed and variable. Next, let's look at what data is needed for the calculation.

Required data for calculation

We already know that the break-even point is calculated taking into account revenue and costs. Costs fall into two categories.

1. Fixed costs. These are expenses that do not depend on sales volume. This may include rent, staff salaries, consisting of salaries, depreciation charges and other expenses that do not change every month. During the year, of course, the amounts may change, because... the lessor may increase the rental price, salaries are periodically indexed, and new property may be purchased that is subject to depreciation. However, such changes do not occur so often, so at the moment we can take the amounts of such expenses as a constant value. If the period to the break-even point is expected to be quite long (more than a year), then correction factors can be used or recalculation made as necessary.
2. Variable costs. These are expenses that depend on how intensively the enterprise operates. These include the cost of raw materials, wages of piece workers, energy costs, transport and logistics costs, taxes and fees.

Some expenses can be classified as semi-fixed or semi-variable. For example, utilities (particularly the cost of electricity) may be included in the rent. Then the rental amount is a constant, and the cost of electricity is variable. Since the main part of the rent is the cost of the rent itself, this is a relatively constant value.

The amount of depreciation is a constant value. But from time to time it may be necessary to upgrade or repair equipment. Then such costs will be conditionally variable.

In addition, for a more detailed analysis, when calculating the company’s break-even point, you may also need a value that reflects the amount of variable costs per unit of production. In our example, this is the cost of preparing one cup of coffee. This includes the cost of the coffee beans required per serving, as well as the cost of labor expressed in man-hours. It is clear that there cannot be any clocks here, because... one serving takes several minutes to prepare, and these will be rather small numbers that are unlikely to be useful for this type of business. But when producing a car, the cost of spare parts, paint and worker wages per unit of production will be significant.

Based on these indicators, you can calculate the unit price and production volume, which will be involved in calculating the break-even point of sales.

And finally, the last indicator that we may need is the so-called marginal income. What is it for? In economics, the marginal income indicator is used to determine the optimal volume of production by regulating costs. It is calculated as follows: the amount of variable costs is subtracted from revenue.

Example. To build a country house, a certain amount of wood is required.
During the season (from April to September) the volume of work increases. Consequently, additional costs increase, in particular, the cost of delivering materials by transport and by the supplier. The commercial director calculated that if you lease two trucks and hire two drivers, delivery costs will be significantly reduced. Of course, leasing implies an overpayment for a car, but per season the marginal income will increase.

What data do you need to calculate your break-even point?

First of all, you will need to know the difference between fixed costs and variable costs. And also:

1. Price of 1 unit of product or service. Denoted as "P".
2. The volume of goods produced and sold in physical terms. Denoted as "Q".
3. Revenue from products that were sold. Denoted as "B".

Fixed costs (denoted as “Zpost”) are production expenses that do not depend on the volume of goods produced. Such expenses, as a rule, do not change over a long period of time.

Fixed costs include:

• Employee salaries, contributions to the Pension Fund, Social Insurance Fund, etc.
• Payment for renting premises.
• Taxes
• Payments on company loans, leasing and other obligations.

Variable costs (denoted as “Zper”). These are production costs that will increase or, conversely, decrease, depending on whether the volume of production increases or, conversely, decreases.

These include:

• The cost of the raw materials from which you make the product, spare parts for equipment, etc.
• Payment for electricity in rented premises, gasoline for cars used for the company’s activities.
• Payment of piecework wages.
• Fare.

This is a classic separation scheme that suits most companies, but not all. Some firms additionally divide costs based on economic rationale.

So, the company's costs can be:

• Conditionally permanent. For example, payments for a warehouse can be divided into rent - as a fixed payment and the costs of storing and moving inventory - as a variable payment. Both payments apply to the warehouse.
• Conditional variables. Thus, the payment for wear and tear of equipment is constant, and expenses for current repairs are variable.

But we are now considering general concepts, so we will focus on the classical system.

Stages of determining the break-even point

Determining the break-even point can be divided into three stages:

1. Collection of necessary data. Both accounting and management accounting data are used for the following indicators:

• actual and expected volume of production and sales in physical and monetary terms;
• amount of expenses;
• gross profit;
• overall financial result.

1. Distribution of costs into fixed and variable, calculation of the break-even point (profitability threshold) and the expected time frame for its achievement.
2. Determining the optimal volume of production and sales for the company to achieve a positive financial result.

Calculation formula

The break-even point, denoted by the abbreviation BEP (break-even point), is calculated in cost and physical terms. Let's consider two types of calculation.

In monetary terms

The break-even point in monetary terms is determined by the formula:

\[ VER_{DEN}=\frac{TR*C_{const}}{TR-C_{var}},where \]

​\( TR \)​ – gross revenue;

​\( C_{const} \)​– fixed costs;

​\( C_{var} \)​ – variable costs.

Example 1. The company’s revenue amounted to 5,250,000 rubles. ($70,000 or UAH 2,030,000), fixed costs – RUB 2,625,000. ($35,000 or UAH 1,015,000), variable – RUB 2,250,000. ($30,000 or 870,000 UAH)).

Let's substitute the values ​​into the formula to calculate the break-even point in cost terms:

​\( VER_{den} \)​=(70000*35000)/(70000-30000)=4,593,750 rub. ($61,250 or 1,776,250 UAH).

This means that with revenue of RUB 5,250,000. ($70,000 or 2,030,000 UAH), the company is already operating at a profit, and with an income of 4,593,750 rubles. ($61,250 or UAH 1,776,250) the financial result will be zero.

You can also calculate the break-even point in another way - through marginal income:

​\( VER_{den}=\frac{C_{const}}{KMR},where \)​

​\( KMR \)​ – marginal income coefficient.

​\( KMR=MR/TR,where \)​

​\( MR \)​ – marginal income.

​\( MR=TR-C_{var} \)​

You can also calculate the marginal income coefficient per unit of product or product:

​\( KMR1\ units=MR1\ units/P \)​

​\( MR1\ units=P-C_{var} \)​

Let's plug the numbers into our example:

​\( MR \)​=70000-30000=40000

​\( KMR \)​=40000/70000=0.57142857142

​\( VER_{den} \)​=35000/0.57142857142=4,593,750 rub. ($61,250 or 1,776,250 UAH).

Thus, when calculating using two formulas, the result was the same.

Let's consider another example, using only the first formula for calculating the break-even point.

Example 2. Revenue from a new project over the past month amounted to RUB 3,750,000. ($50,000 or 1,450,000 UAH). Fixed expenses – 750,000 rubles. ($10,000 or 290,000 UAH), variable – 4,125,000 rubles. ($55,000 or UAH 1,595,000).

​\( VER_{den} \)​=(50000*10000)/(50000-55000)=-7,500,000 rub. ($100,000 or 2,900,000 UAH).

A negative break-even point means that the amount of variable costs associated with a given project is determined incorrectly. The break-even point characterizes sales volume, which cannot be expressed as a negative number.

Why did we get a negative value? Where is the error?

In the initial stages of project development, costs may exceed sales, and this is completely normal. Perhaps, when delivering goods to a large chain for the first time, the company paid a large entry bonus, which was included in variable costs. But you need to understand that these expenses are one-time expenses. This bonus should have been divided by the number of months of the project, and the revenue should have been used not actual, but expected.

In kind

Now let's calculate the break-even point in physical terms. We use the following conditions:

• fixed costs – RUB 2,625,000. ($35,000 or UAH 1,015,000);
• the selling price of a unit of goods is 150 rubles. ($2 or 58 UAH);
• variable costs per unit – 64 rubles. ($0.85 or 25 UAH).

\[ VER_{nat}=\frac{C_{const}}{P-C_{var\ 1\ units}} \]

​\( VER_{nat} \)​=35000/(2-0.85)=30435 units.

Thus, in order to break even, you need to sell 30,435 units of goods.

Now we know that the break-even point can be measured in units of goods (products, works or services) or in monetary terms.

Is it possible to calculate the break-even point using a formula using balance sheet data?

Unfortunately, the balance sheet does not separate costs into fixed and variable. From the appendix to the balance sheet “Income Statement” you can take only the amount of revenue for the reporting period (most often a year). And even then this amount can be used to calculate the break-even point of the enterprise as a whole. If calculations for the project are required, management accounting data is required.

Break-even point value in monetary terms

The break-even point formula in monetary terms reflects the cost of production required to achieve a zero result.

If the break-even point is reached, then income covers expenses. Subsequently, when the break-even point is exceeded, organizations begin to make a profit. If the break-even point is not reached, the company is forced to incur losses.

The monetary break-even point formula helps management in determining the financial stability of the company.

As the break-even point increases, we can talk about problems related to making a profit. The indicator may change during the growth of the enterprise itself, as trade turnover increases, that is, a sales network is established and prices change.

Examples

Let's calculate the break-even point using the example of an enterprise. We will carry out the calculation based on the reporting data for the previous quarter. We will present the initial data in a table.

Let's calculate the marginal income and the marginal income coefficient:
​\( MR \)​=150000-43500=7,987,500 rub. ($106,500 or 3,088,500 UAH)

\( KMR \)=106500/150000=0.71

Now let’s calculate the break-even point in monetary terms using the formula we already know:

​\( VER_{den} \)​=30600/0.71=3,232,425 rub. ($43,099 or 1,249,871 UAH)

To control, let’s perform the calculation using another formula:

​\( VER_{den} \)​=(150000*30600)/(150000-43500)=3,232,425 rub. ($43,099 or 1,249,871 UAH)

Next, we calculate the break-even point in physical terms. To do this, we first calculate the value of variable costs per unit of goods:

​\( C_{var\ 1\ units} \)​=43500/7500=435 rub. ($5.80 or 168 UAH)

​\( VER_{nat} \)​=30600/(20-5.8)=2155 pcs.

To make sure that the calculations were performed correctly, let’s check the control ratios in cost and physical terms:

43099/150000=0.29

2155/7500=0.29

So, we have determined that the profitability threshold was reached when 2,155 units of products were produced in the amount of 3,232,425 rubles. ($43,099 or UAH 1,249,871), which is 29% of the actual revenue for the quarter.

The found break-even point indicates that the company began to operate with a profit approximately by the end of the first month of the quarter. It is very important not to confuse the break-even point and the payback period. What is the difference?

At the break-even point, the company's profit is zero. The payback period occurs when the profit covers the initial investment. It is profit, not gross revenue.

The question may arise: how is the break-even point calculated for several types of products?

Let's assume the company has released:

For each type of product, you need to calculate the marginal income coefficient and the variable cost coefficient:
​\( MR1 \)​=25000-8000=1,275,000 rub. ($17,000 or 493,000 UAH)

​\( KMR1 \)​=17000/25000=0.68

​\( MR2 \)​=175000-73000=RUB 7,650,000 ($102,000 or 2,958,000 UAH)

​\( KMR2 \)​=102000/175000=0.58

​\( KC\ var\ 1 \)​=8000/25000=0.32

​\( KC\ var\ 2 \)​=73000/175000=0.42

We determine the general coefficient of variable costs by calculating the arithmetic average:

​\( KCvar\ total \)​=0.32+0.42/2=0.37

And then we calculate the break-even point using the general (average) variable expense ratio:

​\( BEPden \)​=120000*(1-0.37)=RUB 5,670,000 ($75,600 or 2,192,400 UAH)

Formulas for calculating the break-even point - how to determine when the company will start making a profit

The break-even point is the sales volume at which the business breaks even, that is, revenue is equal to costs. After achieving it, the company will begin to earn profits. Let's look at this work using a simplified example.

LLC "Kaloriya" is a confectionery from St. Petersburg. She opened quite recently and does not yet know how many cakes and at what price she needs to sell in order to make a profit.

For renting a retail space with a kitchen, the confectionery shop pays 250 thousand rubles per month, for utilities, security and other fixed fees - 50 thousand rubles. The total salary of two cooks, an accountant and a salesperson, together with insurance premiums, is 200 thousand rubles. These 500 thousand rubles are fixed expenses.

In addition to fixed costs, there are also variable ones. These include the purchase of flour, filling, sprinkles, eggs, packaging and other resources for the production of cakes. It costs about 900 rubles to bake one cake, but they sell it for 1,400 rubles.

Let's analyze the calculation of the break-even point step by step.

1. Determine the quantity of products that must be produced to cover costs.

To do this, divide the fixed costs by the difference between the selling price of the cake and the cost of producing it (contribution margin per unit).

Number of cakes to cover costs = 500,000 / (1,400 - 900) = 500,000 / 500 = 1,000 pieces.

Kaloriya LLC will begin to break even when it sells 1,000 cakes per month.

2. Determine how much cakes need to be sold for in order not to make a loss.

To do this, multiply the quantity of products that must be sold to cover costs by its selling price.

Break-even revenue = 1,000 cakes × 1,400 rubles = 1,400 thousand rubles.

Kaloriya LLC must sell products worth 1,400 thousand rubles in order not to make a loss this month.

3. Check whether the calculated amount corresponds to the company's costs.

To do this, calculate the total costs with revenue of 1,400 thousand rubles.

The constant part of the confectionery's costs is always equal to 500 thousand rubles. To determine total variable costs, you need to multiply the cost of producing one cake by the volume of output.

Variable costs of Caloria LLC = 900 rubles × 1,000 cakes = 900 thousand rubles.

Total costs of Kaloriya LLC = 900,000 rubles + 500,000 rubles = 1,400 thousand rubles.

We see that costs equal revenue, which corresponds to the break-even point. In the graph below, this is the point that refers to a production volume of 1,000 units.

The break-even point is at the intersection of direct revenue and total costs

Break-even point model in Excel

Many economists and financial analysts use the most famous spreadsheet processor for various calculations and forecasts. The main advantage of this program is that with any adjustments, the calculation results are recalculated automatically. This is very convenient for determining the optimal sales result, cost control and other financial planning functions.

The above profitability threshold graph was constructed based on a table with data on expenses and sales volume. Using the formula, we calculated the revenue and profit for each number of units of the product.

Break-even point and practice of using it

Break-even point analysis is used for various purposes. Let's consider some directions and purposes of using this indicator. The table below shows the purposes of possible use of the break-even point indicator in economic practice.

The use of the break-even point model is used in management decisions and allows you to give a general description of the financial condition of the enterprise, assess the level of critical production and sales to develop a set of measures to increase financial strength.

★ Calculate break-even point in Excel in 5 minutes

Organizational break-even planning

Making a profit is the main goal of any business enterprise. Break-even planning is an important part of your financial plan. How to calculate the break-even point in a business plan?

To do this, you need to use forecasts that are based on real data. For example, actual revenue for the previous period amounted to RUB 7,500,000. ($100,000 or UAH 2,900,000), but the company expanded its material and production base and, accordingly, the costs of raw materials, equipment and staff increased. Therefore, we need to calculate the sales volume at which the profitability threshold will be passed.

But a reasonable question arises: revenue is involved in calculating the break-even point, then what value should we substitute into the formula if the expected revenue is not yet known to us?

You can use actual revenue for the previous period. It is also possible to substitute the amount of the enterprise's expected income into the formula. But expenses should be taken into account those that were actually incurred under new conditions (for example, expansion of production or sales markets, creation of a new project, etc.). At the same time, let me remind you once again that large one-time expenses, such as the purchase of equipment, must be taken into account as part of variable costs and distributed proportionally over the period for which the profitability threshold is calculated.

Model for calculating the break-even point of an enterprise

When calculating the break-even point, enterprises use the following assumptions and simplifications of reality:

• Product output and costs have a linear relationship (have a linear trend of change);
• Variable costs and product prices are constant over the future period under consideration;
• Production capacities are constant, the structure of products does not change;
• Inventories of finished products are not significant and will not distort the assessment of the enterprise’s break-even point. In other words, production equals sales;
• Variable costs can be predicted and accurately estimated in the future;

As we can see, the conditions for assessing the break-even point are ideal: stable market, production and organizational conditions. In reality, product output, sales and costs are influenced by many external factors that are difficult to predict in the planning period. Still, let’s consider an ideal model for calculating the break-even point of an enterprise.

Break-even point analysis

Break-even point analysis (CVP analysis) examines the relationship between sales volume, costs and profit. The abbreviation CVP is derived from the English words Cost (cost), Volume (volume) and Profit (profit).

In other words, analysis of the break-even point is carried out at the enterprise to study the impact of changes in income and expenses on profit margins.

Let's move a little away from the numbers and think: how to increase profits? There are two ways:

1. Earn more, i.e. increase production and sales volumes. But this method also implies an increase in costs.
2. Spend less, i.e. optimize costs.

Cost optimization does not imply reducing costs at the expense of quality deterioration. This is a broad aspect of financial planning that may include:

• searching for better prices for raw materials;
• determining the terms of contracts providing for a bonus system for sales volume;
• personnel outsourcing;
• own logistics service;
• reduction of the tax base within the framework of legislation, etc.

The break-even point is determined by the analytical method as the amount of gross income required to cover basic costs. But there is also interest (if you use bank loans), which is not included in the calculation of gross profit, as well as tax penalties paid from net profit.

Thus, if we use balance sheet data, the company's break-even point allows us to determine the minimum acceptable amount of gross income without borrowing funds.

Advantages and disadvantages of the break-even point model

The advantages of the model include the following:

1. Simplicity. The calculations use simple formulas, and data can be easily collected from accounting and management accounting.
2. Dividing costs into fixed and variable costs is very useful for financial analysis. Accounting rules do not require such classification, and this simple work will help obtain more reliable data on financial results. After all, it is necessary to plan the amount of profit not only for tax purposes, but also to increase the investment attractiveness of the company.

Disadvantages of the model:

1. Does not take into account seasonality, exchange rate fluctuations, the introduction of new technologies and other external factors.
2. If there is a large range of products, prices for individual items may vary. In this regard, calculations may be distorted.
3. The increase in fixed costs occurs unevenly. For example, rent may increase every year, but wages may increase quarterly. Due to this stepwise increase in fixed costs, calculations may not be current.

Why do you need to know the break-even point?

The value of this indicator is important for assessing the current financial condition of the enterprise, as well as for economic planning for the future. The break-even point allows you to:

• Determine the feasibility of expanding production, dealer network, mastering new technologies and types of products;
• Assess solvency and financial stability, which is important for company owners, investors and creditors;
• Monitor changes in indicators over time and identify bottlenecks in the production process;
• Calculate and plan a sales plan;
• Determine the acceptable amount of revenue reduction or the number of units sold so as not to go to a loss;
• Calculate the impact of changes in price, production costs and sales volume on the financial result.