A few months ago, I wrote a post explaining break-even analysis and how it can help you assess how worthwhile a project is. However, it might be helpful to expand that post, add an example, an online calculator (scroll to the bottom of this page) and explain how you can use the break-even point formula for your product or project analysis.
Break Even Formula
It might be easier to start with the formula of the break-even point. First of all, the break-even point is when you make no profit, but you also incur no losses. In other words, it’s the point where the total profit that a product generates equals the total fixed costs. So, the break-even formula is:
Break-Even Point= Fixed Costs / (Sales Price – Variable Costs)
Break Even Analysis
As explained above, the break even point is calculated by dividing the total fixed cost by the contribution of each unit. By saying contribution, we mean the revenue per unit less the variable costs per unit. In terms of analysing or explaining the break even point, a high break even point or a large number of units necessary to cover the fixed costs can mean either that the contribution is low (low price per unit or low margins) or the fixed costs are high.
Break Even Example
For example, if your company is thinking of launching a new product that will have $500,000 fixed costs while the sale price for one unit is $10 and the variable costs (such as materials and supplies) will be $5, then the break even point will be:
$500,000 / ($10 – $5) or 100,000 units
In other words, using this example, you will have to produce and sell 100,000 units to break even.
A second example might be more illustrative. Let’s say that you have two products that you can develop. However, you can not establish both products at the same time. You need to choose either Product A or Product B.
Product A has these characteristics:
- Sales price : $2 per unit
- Variable Costs : $1.5 per unit
- Fixed Costs: $5000
Product B has :
- Sales Price : $4 per unit
- Variable Costs $2 per unit
- Fixed Costs: $20,000
The break even point for product A is : (5,000/0.5) or 10,00 units to break even. The break even point for product B is : (20,000/2) or 10,000.
So which product would you choose to develop? You will need the same amount of sales to break even for both products, and product B has a higher contribution.
There is definitely more than one factor that I would consider, such as the reliability of the information that I am using to perform my analysis. Being risk-averse, I would choose product A. The reason? If I lose, I will only lose $5,000. The second scenario is a bit riskier due to the high fixed costs. Of course, this is a matter of preference and the way people assess and perceive risk.
Break Even Calculator
A simple calculator to help you find out how many units of a product you will need to sell to break even. Break even analysis is a straightforward approach to help you understand if the product you are developing is likely to be successful and if you will be able to cover the fixed costs by using the projected sales that you will be able to make.
The only inputs you need are the revenue per unit, the variable cost per unit and the total fixed cost attributed to the development of this product.