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Fixed vs. variable costs: How to compute break-even

Break-even analysis can be useful when investing in new equipment, launching a new product or analyzing the effects of a cost reduction plan. The break-even point is fairly easy to calculate using information from your company’s income statement. Here are the details.

Analyzing your costs

Break-even can be explained in a few different ways. It’s the point at which total sales are equal to total expenses. More specifically, it’s where net income is equal to zero and sales are equal to variable costs plus fixed costs.

To calculate your break-even point, you need to understand a few terms:

Fixed expenses. These are the expenses that remain relatively unchanged with changes in your business volume. Examples: property taxes, salaries, insurance and depreciation.

Variable/semi-fixed expenses. Your sales volume determines the ebb and flow of these expenses. If you had no sales revenue, you’d have no variable expenses and your semi-fixed expenses would be lower. Examples: shipping costs, materials, supplies, advertising and training.

Applying the break-even formula

The basic formula for calculating the break-even point is:

Break-even = fixed expenses / 1 – (variable expenses / sales).

Break-even can be computed on various levels: It can be estimated for the company overall or by product line or division, as long as you have requisite sales and cost data broken down. For example, let’s suppose Division A generates $12 million in revenue, has fixed costs of $1 million and variable costs of $10.8 million. Here’s how those numbers fit into the break-even formula:

Annual break-even = $1 million / 1 – ($10.8 million / $12 million) = $10 million

Monthly break-even = $10 million / 12 = $833,333

As long as expenses stay within budget, the break-even point will be reliable. In the example, variable expenses must remain at 90% of revenue and fixed expenses must stay at $1 million. If either of these variables changes, the break-even point will change.

Real-world applications

Many companies use break-even point to set revenue goals and prepare budgets. In addition, break-even analysis can tell you the amount of incremental sales you need to recoup an investment, such as buying a new machine or hiring a new salesperson. Alternatively, break-even can help gauge the effects of cost reduction plans. Contact us if you have questions or need help working through the calculations.

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This entry was posted on Tuesday, February 13th, 2018 at 11:07 am. Both comments and pings are currently closed.