Break-Even Point Formula for Businesses

You’re probably not interested in just breaking even. You want to make money in your business. But knowing what quantities you need to sell just to cover your expenses is often super-helpful. If you own a one-person accounting firm (or some other service business), for example, how many hours do you need to work to pay your expenses and perhaps pay yourself a small salary? Or, if you’re a retailer of, say, toys, how many toys do you need to sell to pay your overhead, rent, and sales clerks?

You see my point, right? Knowing how much revenue you need to generate just to stay in the game is essential. Knowing your break-even point enables you to establish a benchmark for your performance. (Any time you don’t break even, you have a serious problem that you need to resolve quickly to stay in business.) And considering break-even points is invaluable when you think about launching new businesses or new ventures.

As you ponder any new opportunity and its potential income and expenses, you need to know how much income you need to generate just to pay those expenses.

To calculate a break-even point, you need to know three pieces of information: your fixed costs (the expenses you have to pay regardless of the business’s revenue or income), the revenue that you generate for each sale, and the variable costs that you incur in each sale. (These variable costs, which also are called direct expenses, aren’t the same thing as the fixed costs.)

Here are some tips to help figure out revenue per sale, variable costs, and fixed costs:

• Whatever you sell — be it thingamajigs, corporate jets, or hours of consulting services — has a price. That price is your revenue per item input — for example, $100 per hour for consulting.
• Most of the time, what you sell has a cost. If you buy and resell thingamajigs, those thingamajigs cost you some amount of money. The total of your thingamajigs’ costs varies depending on how many thingamajigs you buy and sell, which is why these costs are referred to as variable costs. A couple of examples of variable costs include hourly (or contract) labor and shipping. Sometimes, however, the variable cost per item is zero. (If you’re a consultant, for example, you sell hours of your time, but you may not pay an hourly cost just because you consult for an hour.)
• Your fixed costs are all those costs that you pay regardless of whether you sell your product or service. If you have to pay an employee a salary regardless of whether you sell anything, that salary is a fixed cost. Your rent is probably a fixed cost. Things like insurance and legal and accounting expenses are probably fixed costs, too, because they don’t vary with fluctuations in your revenue.

Fixed costs may change a bit from year to year or bounce around a bit during a year, so maybe fixed isn’t a very good adjective. People use the term fixed costs, however, to differentiate these costs from variable costs, which are those costs that do vary with the number of goods you sell.

Take the book-writing business as an example. Suppose that as you read this book, you think, “Man, that guy is having too much fun. Writing about accounting programs, working day in and day out with buggy beta software — yeah, that would be the life.” So, you start writing books.

Further, suppose that for every book you write, you think that you can make $5,000, but you’ll probably end up paying about $1,000 per book for such things as long-distance telephone charges, overnight-courier charges, and extra hardware and software. Also suppose that you need to pay yourself a salary of $20,000 per year. (In this scenario, your salary is your only fixed cost because you plan to write at home at a small desk in your bedroom.) The following table shows how the situation breaks down.

Costs and Revenue

With these three bits of data, you can easily calculate how many books you need to write to break even. Here’s the formula: Fixed Costs / (Revenue – Variable Costs)

If you plug in the writing-business example data, the formula looks like this:

Work through the math, and you get 5. So, you need to write (and get paid for) five books per year to pay the $1,000-per-book variable costs and your $20,000 salary. Just to prove that this formula really works, this table shows how things look if you write five books.

The Break-Even Point

Accountants use parentheses to show negative numbers. That’s why the $5,000 and the $20,000 in the table are in parentheses.

But back to the game. To break even in a book-writing business like the one that I describe here, you need to write and sell five books per year. If you don’t think that you can write and sell five books in a year, getting into the book-writing business makes no sense.

Your business is probably more complicated than book writing, but the same formula and logic for calculating your break-even point apply. You need just three pieces of information: the revenue that you receive from the sale of a single item, the variable costs of selling (and possibly making) the item, and the fixed costs that you pay just to be in business.

QuickBooks doesn’t collect or present information in a way that enables you to easily pull the revenue per item and variable costs per item off some report. Neither does it provide a fixed-costs total on some report. If you understand the logic of the preceding discussion, however, you can easily massage the QuickBooks data to get the information you need.