Break-even point: 5 easy steps to understand pricing and ensure profitability
By Pam Newman
How many units (products or hours of service) do you have to provide to cover your costs? Don't know? Well, then it is about time to find out! Follow these 5 Easy Steps to Understanding Your Break-Even Point! It's the key to determining your pricing and profitability!
- First of all, you need to know your selling price and the direct costs of the product/service you provide per unit. Direct costs are classified as costs going into the product or service (Direct materials and Direct Labor).
- Once you know your selling price and your direct costs per unit, you can calculate your contribution margin in dollars per unit. This is the amount of money you get over and above your direct costs for each unit you sell. (You can define your unit as product or hour of service.) So if your selling price was $50 and your direct costs were $40, then your contribution margin in dollars would be $10 per unit.
- Next, you need to calculate your overhead costs. What are all the other costs you incur in your business that need to be covered before you can start earning a profit? Overhead costs include costs such as insurance, indirect labor, rent, taxes, advertising, office supplies, etc. This is done in total, not a per unit basis.
- Once you have your overhead costs totaled, you will take this total number and divide it by your contribution margin in dollars per unit (Answer from #2 above). For example, if your overhead was $1000 and your contribution margin from each unit you sell is $10, then your Break-Even in units would be $1000/$10 = 100 units. So in this example, you must sell 100 units at $50 to break-even. Remember, there is no profit in your business until you've covered your direct and indirect (overhead) expenses. So only after selling 100 units will you break-even. Starting with the 51st unit, you'll be earning a profit.
- As your selling price, direct costs and indirect costs change, then your break-even point will fluctuate also. It is priceless to know your break-even point. What would happen if you have to have 100 units in sales to break-even and you only sell 80 units? Then you'll never breakeven, let alone be profitable. This type of break-even calculation is something you need to be incorporating as part of your pricing policy to ensure that you are making money on every unit you sell and that you will be able to be profitable based upon your costs and your sales. If you are not profitable, then you will not stay in business.
It is imperative that you know your break-even point and that you monitor it on a consistent basis to ensure a profitable and long-living business! Every type of business can incorporate this equation into their pricing module. It might just make the difference between a profitable and nonprofitable year for you!
About the author
Pam Newman is the author of "Out of the Red" and "Unlocking the Secrets of QuickBooks," a Certified Management Accountant, and a Certified QuickBooks Financial and Point-of-Sale ProAdvisor. For more information, contact her at 816.304.4398 or www.rppc.net.