What is a break-even point and how do you compute it?
The break-even point in your business is where all direct and indirect costs have been met. You are neither making nor losing any money. The break-even point can be measured in number of units sold, dollars of total sales or possibly hours billed out.
To calculate your break-even point, you must first determine your direct (variable) and your indirect (fixed) costs.
Direct costs vary with the number of units sold. For every unit you sell, you must buy another set of the components.
Your indirect costs don’t normally vary for a given volume of business. Your gross profit per unit (sales less direct costs, known as the contribution margin) goes toward paying for these indirect costs. Once the indirect costs have been paid, you have reached the break-even point.
The gross profit from every unit sold over the break-even point goes to the bottom line as profit.
To simplify this example, let’s assume that you run a food stand that sells only hamburgers. For every burger you sell, you need to buy meat, bun, trimmings, and a paper serving plate. Assume your burger sells for $6 and the total of the above direct costs is $2 per burger. This means that you have a contribution margin of $4 to go toward fixed costs.
Your fixed costs include such things as rent, insurance, advertising, taxes and so on. Within limits, selling a few more burgers will not cause these expenses to increase. If your total fixed costs are $100 a day, your break-even point is 25 burgers or $150. Once you pass 25 burgers, $4 from each additional sale goes to your bottom line as profit.
For assistance in determining your break-even point and its effect on your profitability, give us a call.
Barry Gilchrist is a certified public accountant at Wessel & Co. of Johnstown.