When will you break even?

Full Coffee Cup 4

Does your business run on cash? or coffee?

It is critically important for you to properly use quality cost information when making basic decisions about your business, such as pricing your goods and planning your sales volume.  Over the past few posts, I’ve explained how to determine fixed costs, variable costs, and contribution margin.  If you haven’t already done so, I encourage you to read those three posts first (they’re short).

Today I want to show you how to find your break-even point.  This is the minimum number of units that you must sell in order to earn zero profit. No loss, no profit.   The formula is, quite simply:

Total fixed costs / contribution margin per unit.

And remember that:

Contribution margin per unit = sales price – variable cost per unit.

Now take my previous example of the bus from Newark to Pittsburgh.  Sales price is $120/seat.  Variable cost is $3/seat.  Fixed cost is $2,895.*  Contribution margin per unit would be $117 (that’s $120 sales price – $3 variable cost).  Break-even point would be 24.74 seats (= $2,895 / 117).  This means that, to break even on a single bus trip, you must sell 25 tickets for $120 each.  With only 24 tickets sold, you’re losing money.  (24 tickets x $120 = 2,880 in revenue; $2,880 – $3,000 total cost = $120 loss.)  With 25 or more tickets sold, you’re breaking even.   (25 tickets x $120 = 3,000 in revenue; $3,000 – $3,000 total cost = $0 net income.)

A good way to visualize this is with coffee.**  Contribution margin is your coffee, and fixed costs represent your empty mug.  To break even, you must fill up the mug (fixed costs) with enough coffee (contribution margin).  Anything that spills over the side is your profit.

Knowing your break-even point will help you to set prices, monitor your profit performance, and manage your costs.  I have long advocated for keeping fixed costs as low as possible.  This type of analysis will help you to understand how to become more financially flexible and improve your profitability.

——————————

*Total cost of a bus ride was $3,000.  Of this, 35 seats x $3/seat = $105 in variable costs.  Remaining cost of $3,000 – $105 = $2,895 total fixed cost.

**In general, coffee is a good a good aide to visualizing things.

[Image: Full Coffee Cup 4 by Paul Prins!, on Flickr]

About Mark P. Holtzman

Chair of Accounting Department at Seton Hall University. PhD from The University of Texas at Austin. Worked at Deloitte's New York Office. BSBA from Hofstra University.

2 Responses to “When will you break even?”

  1. hi im having a bit of a problem here im trying to calculate break even points with only the following information provided: Omega is planning an event and is expecting the following costs:
    Dinner R7
    favour and program R3
    orchestra R1500
    Tickets and advertising R700
    riverboat rental R4800
    entertainers R1000
    1) compute braek even points for the event (in terms of persons that must attend)
    2)With 250 people attending this year, what price per ticket must be charged in order to break even?

    Please help im trying to study for my exam on monday but im having a hard time figuring this out, i dont have any previous accounting expirience so this is proving hard.

    • Kholo, to solve this, you need to calculate the contribution margin per unit and total fixed costs. Then divide total fixed costs by the contribution margin per unit to get the break-even point. Are you looking for break-even point in dollars or units?

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