Calculating break-even is a theoretical algorithm and can only be used in a strict sense if all of the future business costs are known with certainty and the mix of sales for several products can again be predicted accurately.
Nether the less, having an estimation of what your business’ total costs are likely to be and a rough idea of how much income is required in order to make a profit is of greater value than not having any budgets or estimates at all.
The break-even point reached as a result of carrying out the calculation might provide an indication of whether the business' prices are adequate and realistic.
The breakeven point (BEP) calculation is as follows:
BEP = Total overheads and indirect costs and overheads divided by contribution per sale.
Consider the following example.
A business start-up has the estimated figures for its first year of trading.
Income £100,000 (made up of sales averaging £5 per item meaning that there will be 20,000 items)
Direct costs £40,000 (average costs per item = £100,000 divided by £5 = 20,000 items. £40,000 divided by 20,000 = £2 per item)
Indirect costs £20,000 (average apportionment per item is £20,000 divided by 20,000 items = £1 each)
The contribution per item equals the sales from one unit less the direct costs of producing that item.
£5 less £2 equals £3 per unit.
BEP = £20,000 divided by £3 = 6666.67 or 6,667 items that the business would have to sell in order to achieve its breakeven point.
In order to check the calculations we can see that:
Sales 6,667 items sold would give 6,667 x £5 = £33,335 in income
Direct costs for producing these items would be 6667 x £2 = £13,335
Contribution made would be £33,335 less £13,335 = £20,000
The total indirect costs of £20,000 are equal to this contribution.
Therefore, if the business makes and sells 6,667 items, it will breakeven.