Breakeven Analysis - Fixed Cost & Variable Cost, & Profit
A breakeven analysis is used to determine how much sales volume your business needs to start making a profit, based on your fixed costs, variable costs, and selling price.
How to Do a Breakeven Analysis
To conduct a breakeven analysis, use this formula:
Fixed Costs divided by (Revenue per unit - Variable costs per unit)
So before you apply the formula you need to know:
Fixed costs are costs that must be paid whether or not any units are produced. These costs are "fixed" over a specified period of time or range of production. Examples of fixed costs include:
- Business premises lease (or mortgage) costs over the contract period
- Startup loan payments (if you financed the business startup costs)
- Property taxes
- Vehicle leases (or loan payments if the vehicle is purchased)
- Equipment (machinery, tools, computers, etc.)
- Payroll (if employees are on salary)
- Some utilities - for example, landline phone and internet charges may not change on a month to month basis
- Accounting fees
For an existing business fixed costs are readily available. For new businesses make sure to do your research and get the most accurate figures available.
Unit variable costs are costs that vary directly with the number of products produced.
For instance, the cost of the materials needed and the labor used to produce units isn't always the same. Examples of variable costs include:
- Wages for commission-based employees (such as salespeople) or contractors
- Utility costs that increase with activity - for example, electricity, gas, or water usage
- Raw materials
- Shipping costs
- Advertising (can be fixed or variable)
- Equipment repair
- Sales costs (such as credit card processing fees, etc.)
Sample Breakeven Computation
Suppose that your fixed costs for producing 30,000 widgets are $30,000 a year.
Your variable costs are $2.20 materials, $4.00 labor, and $0.80 overhead, for a total of $7.00.
If you choose a selling price of $12.00 for each widget, then:
$30,000 divided by ($12.00 - 7.00) equals 6000 units.
This is the number of widgets that have to be sold at a selling price of $12.00 to cover your costs. Each unit sold beyond 6000 generates $5 profit.
|Fixed Costs for 30,000 widgets (per year)|
|Total Fixed Costs||$30,000|
|Variable Costs (per unit produced)|
|Total Variable Cost (Per Unit)||$7.00|
|Selling Price Per Unit||$12.00|
|Selling price - variable costs||$5.00|
|#Units to sell/year to breakeven ($30,000 / $5.00)||6000|
|#Units to sell/year to generate $10,000 profit||8000|
|#Units to sell/year to generate $50,000 profit||16000|
Using BreakEven Calculations
Breakeven analysis allows you to compute various "what if?" scenarios to reduce your breakeven point and increase profits:
- Increasing the selling price - in the above example, if you were able to increase the selling price by $1 you would only need to sell 5000 units to break even ($30,000 / ($13 - $7). Selling 6000 units would give you a profit of $6000 (1000 units multiplied by $6 cost per unit). However, in a highly competitive environment increasing the selling price is often not an option.
- Reducing your fixed costs - if you were able to reduce your fixed costs by $5000 you would also reduce the breakeven point to 5000 units sold. Reducing rent and payroll are common ways for businesses to reduce fixed costs, as is relocating to other jurisdictions that have lower business taxes or utility costs.
- Reducing variable costs - reducing the variable costs by $1 would also lower the breakeven point 5000 units. Variable costs are typically lowered by reducing material or labor costs, for example, a builder sourcing lumber from a lower-cost supplier or taking advantage of equipment and/or technology to automate production.
- Increasing sales - assuming breakeven unit sales of 6000, increasing the number of units sold to 10000 would give a profit of $20,000 (4000 units multiplied by $5 cost per unit). This calculation can be used when considering the benefits of advertising. Say for example you decide to increase your advertising budget by $5000 per year, which would raise your fixed costs to $35,000. This would raise your breakeven unit sales to 7000 - anything less means your ad campaign was not successful.
Examples: Alison used a breakeven analysis to determine what prices she should set for her software products.