The break even point (BEP) is the point at which a business does not make a profit or a loss. Iit happens when the revenue generated by the business is equal to its expenses. In order to produce a profit, a business must always be working towards a lower break even point.
The BEP defines the amount of revenue or sales units that a business has to sell to break even. It is given by the break even point formula as follows:
As can be seen from the formula the business has three distinct ways of forcing a lower break even point.
- Firstly reduce the total fixed costs of the business.
- Secondly increase the unit selling price of the product.
- Finally reduce the variable cost per unit for the product.
Lower Break Even Point Example
Suppose a business has fixed costs of 42,000 and produces a product with variable unit costs of 11.00 and a unit selling price of 25.00. Additionally the business currently sells 2,500 units.
The current breakeven point is calculated using the formula as follows:
BEP = Fixed costs / (Selling price - Variable cost) BEP = 42,000 / (25.00 - 11.00) BEP = 3,000 units
The business currently sells 2,500 units but has a breakeven point of 3,000 units. As it currently stands the business will make a loss of 7,000 calculated as follows:
Profit = Revenue - Costs Profit = Revenue - Variable costs - Fixed costs Profit = 2,500 x 25.00 - 2,500 x 11.00 - 42,000 Profit = -7,000 (loss)
Assuming the business cannot simply sell more units (in this case 500 additional units), it should now consider the three ways of obtaining a lower break even point.
Reduce the Total Fixed Costs of the Business
All businesses have fixed costs such as rent, administration salaries, selling and marketing costs etc. In this context, they are the costs which are not included in the costs of producing the product.
If our business is to have a lower break even point of 2,500 units, then using the BEP formula the required fixed costs can be calculated as follows:
BEP = Fixed costs / (Selling price - Variable cost) 2,500 = Fixed costs / (25.00 - 11.00) Fixed costs = 35,000
To force down the break even point to 2,500 units, the business must reduce its fixed costs by 7,000 from 42,000 to 35,000. The reduction of 7,000 might come from efficiency savings, reductions in advertising and marketing budgets, subletting unused office space etc.
Increase the Unit Selling Price of the Product
As an alternative, if the market allows, the business might achieve a lower break even point by increasing its products selling prices. Again using the BEP formula, the selling price required to bring the break even point down to 2,500 units can be calculated as follows:
BEP = Fixed costs / (Selling price - Variable cost) 2,500 = 42,000 / (Selling price - 11.00) Selling price = 27.80
To reach a lower break even point of 2,500 units, the business needs to increase its selling prices by 2.80 from 25.00 to 27.80, a 11.2% increase. This can only be determined by market conditions, and is not entirely under the control of the business. Care must also be taken to ensure that the increased selling price does not cause the units sold to fall.
Reduce the Variable Cost per Unit for the Product
Finally, the business can reduce the variable costs needed to make the product. Using the BEP formula the variable cost needed to allow the business to break even at 2,500 units is as follows:
BEP = Fixed costs / (Selling price - Variable cost) 2,500 = 42,000 / (25.00 - Variable cost) Variable cost = 8.20
The break even analysis calculation shows the business needs to reduce the product cost by 2.80 from 11.00 to 8.20, a reduction of 25.45%. Again the feasibility of this depends on whether the business can make efficiency savings, and reduce the direct material and labor costs incurred in manufacturing the product.
Using a Combination of the 3 Methods to Lower Break Even Point
In practice, a business will use all three methods in combination with each other to force down the break even point.
To illustrate suppose the business can increase its selling price from 25.00 to 26.00 (4.0%), reduce its cost price from 11.00 to 10.00 (9%), and reduce its overheads from 42,000 to 40,000 (4.8%). In this case the new break even is calculated as follows:
BEP = Fixed costs / (Selling price - Variable cost) BEP = 40,000 / (26.00 - 10.00) BEP = 2,500
By making smaller adjustments to each of the variables in the formula, the break even point has been forced down to the required 2,500 units.
Break Even and the Financial Projections Template
Our break even calculator can be used to calculate the break even point for up to four different scenarios. This is done by inserting values for unit selling price, unit variable cost, and total fixed costs.
By using this calculator the business can find the optimum values needed to achieve a lower break even point. The fixed costs and the gross margin percentage generated by this calculator can then be included in our financial projections template to produce the projections for the business.
Additionally the break even revenue is included in our financial projections template on the financial ratios page.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.