What is a break-even analysis & how to calculate it?

Whether you’re opening a company, sussing out a business idea, or looking to make strategic decisions, it's important to understand your break-even point.

Here, we'll unpack what a break-even point is and how to calculate it so you can better reach your business goals.

What is a break-even point?

A break-even point is the point at which your total business cost is equal to your total business revenue.

What does it mean to break even, exactly? When you reach a break-even point, you're not operating at a loss or a gain. You're spending just as much as you're earning.

What is a break-even analysis?

A break-even analysis is a calculation for determining the point at which your costs will equal your revenue. Simply put, a break-even analysis helps you see how much money you need to earn or units you need to sell to cover your expenses and begin making a profit.

How a break-even analysis works

Businesses can conduct break-even analyses by tracking and calculating their fixed costs, variable costs, and sales price per unit. They may use their analysis to determine the break-even point for their entire operation or for individual products and services.

A break-even analysis is commonly conducted for internal purposes, though it may be shared with third parties like investors and lenders.

Why is a break-even analysis important?

Understanding your break-even point is important for managing a business. It can help you:

• Refine pricing. Increase or decrease your sales price per unit to help offset your costs and reach your break-even point.
• Determine the feasibility of your business idea. Before you seek investors or take out a loan for a new business, use a break-even analysis to understand how long it will take to turn a profit.
• Set new sales goals. If you're looking to reach a new revenue target, you can use a break-even analysis to see how many units you need to sell at a certain price and cost.

When to use a break-even analysis

You can use a break-even analysis to make more informed decisions in scenarios like:

• Starting a business. Build your break-even point into your business plan and prove your idea's viability to potential investors and lenders.
• Adding costs. If you're adding employees, products, or infrastructure, that means you'll be raising costs. And you can use a break-even calculation to see how long it will take to recoup those costs.
• Lowering prices. You may lower sales prices to edge out competitors or make your products more accessible to target customers. A break-even analysis can help you see how much you need to adjust costs to make up the difference.
• Expanding a business. Evaluate the risk of new investments, acquisitions, or pivots in your business plan with a break-even analysis.

What is the standard break-even time period?

It's important to consider how long it will take you to reach your break-even point so you can plan accordingly. If it takes one year to break even, for example, you'll want to figure out how to manage cash flow for the next 12 months. If it takes more than a year, you may try adjusting your business plan to shorten that length of time and start recouping costs sooner.

A standard break-even time period is typically six to 18 months. If your break-even point is more than 18 months away, you may need to reconsider your business idea because of its financial risk.

How to calculate?

Now, let's do the math with the break-even point formula:

Break-even point (units) = fixed costs / (sales price per unit - variable cost per unit)

Consider this break-even analysis example:

10,000 units = $12,000 / ($2 - $0.80)

This means if your fixed costs are $12,000 and your variable cost per unit is $0.80, you need to sell 10,000 units at $2 a unit to break even.

To break this down further, these costs include…

• Fixed costs. Necessary, recurring, and unchanging expenses, such as rent, payroll, insurance, and taxes.
• Variable cost per unit. Expenses that increase and decrease depending on your sales and business needs, including shipping costs, sales commissions, and utilities.
• Sales price per unit. The price you set for your product or services, based on your costs, competition, and target market.

What does contribution margin mean?

A contribution margin is the difference between a product's sale price and its variable cost. Basically, it's the portion of the break-even equation that's divided by your fixed costs.

You can calculate this value by using the contribution margin formula:

Unit contribution margin = sales price per unit - variable cost per unit

If you sell a handbag for $200, for example, and its variable cost is $60, then your contribution margin is $140.

Your contribution margin is important because it can help you see how much profit you earn from each product. It can also help you understand and work toward your break-even point. When your contribution margin equals your fixed costs, you've reached your break-even point. When your contribution margin is greater than your fixed costs, you've earned a profit.

How to leverage this analysis?

A break-even analysis can help you make informed decisions so you can earn a profit and grow your business.

If you need to achieve your break-even point sooner, for example, you can raise your product prices or decrease your business costs. Still, you should ask questions like: Will customers continue to purchase our products at higher prices? Will cutting costs impact quality or scale? Conduct further market research to answer these questions and find the best solutions for your business needs.

PayPal for Business

Manage expenses, access tools to grow your business, and track and measure performance from one place. You do the business, and we help with the details.

Get started with PayPal for Business.