To find the total units required to break even, divide the total fixed costs by the unit contribution margin. Break-even analysis involves a calculation of the break-even point (BEP). The break-even point formula divides the total fixed production costs by the price per individual unit less the variable cost per unit. At 175 units ($17,500 in sales), Hicks does not generate enough sales revenue to cover their fixed expenses and they suffer a loss of $4,000.

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The formula for break-even point (BEP) is very simple and calculation for the same is done by dividing the total fixed costs of production by the contribution margin per unit of product manufactured. If the company can increase its contribution margin per unit to $8 (by perhaps lowering its per unit variable cost), it only needs to sell 8,750 ($70,000 / $8) to break even. First we take the desired dollar amount of profit and divide it by the contribution margin per unit. The computes the number of units we need to sell in order to produce the profit without taking in consideration the fixed costs. The purpose of the break-even analysis formula is to calculate the amount of sales that equates revenues to expenses and the amount of excess revenues, also known as profits, after the fixed and variable costs are met. Let’s take a look at a few of them as well as an example of how to calculate break-even point.

1. In effect, the insights derived from performing break-even analysis enables a company’s management team to set more concrete sales goals since a specific number to target was determined.
2. Barbara is the managerial accountant in charge of a large furniture factory’s production lines and supply chains.
3. Now Barbara can go back to the board and say that the company must sell at least 2,500 units or the equivalent of $1,250,000 in sales before any profits are realized.
4. For each additional unit sold, the loss typically is lessened until it reaches the break-even point.
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6. After the next sale beyond the break-even point, the company will begin to make a profit, and the profit will continue to increase as more units are sold.

The denominator of the equation, price minus variable costs, is called the contribution margin. After unit variable costs are deducted from the price, whatever is left—​​​the contribution margin—​is available to pay the company’s fixed costs. Now, as noted just above, to calculate the BEP in dollars, divide total fixed costs by the internal controls accounting contribution margin ratio.

Why Is the Contribution Margin Important in Break-Even Analysis?

After entering the end result being solved for (i.e., the net profit of zero), the tool determines the value of the variable (i.e., the number of units that must be sold) that makes the equation true. In effect, the insights derived from performing break-even analysis enables a company’s management team to set more concrete sales goals since a specific number to target was determined. At that breakeven price, the homeowner would exactly break even, neither making nor losing any money. In accounting, the margin of safety is the difference between actual sales and break-even sales. Managers utilize the margin of safety to know how much sales can decrease before the company or project becomes unprofitable.

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Thus, to calculate break-even point at a particular after-tax income, the only additional step is to convert after-tax income to pre-tax income prior to utilizing the break-even formula. In order to find their break-even point, we will use the contribution margin for the Blue Jay and determine how many contribution margins we need in order to cover the fixed expenses, as shown in the formula in Figure 3.4. The Break-Even Point (BEP) is the inflection point at which the revenue output of a company is equal to its total costs and starts to generate a profit.

The break-even point can be affected by a number of factors, including changes in fixed and variable costs, price, and sales volume. Therefore, ABC Ltd has to manufacture and sell 100,000 widgets in order to cover its total expense, which consists of both fixed and variable costs. At this level of sales, ABC Ltd will not make any profit but will just break even. The contribution margin represents the revenue required to cover a business’ fixed costs and contribute to its profit. With the contribution margin calculation, a business can determine the break-even point and where it can begin earning a profit.

Break Even Point Calculation Example (BEP)

While the breakeven point is a valuable tool for decision-making, it has several limitations. One major downside is its reliance on the assumption that costs can be neatly divided into fixed and variable categories. For example, semi-variable costs, which have both fixed and variable components, can complicate the accuracy of the breakeven calculation which then changes the breakeven point in units. Note that in the prior example, the fixed costs are « paid for » by the contribution margin. The more profit a company makes on its units, the fewer it needs to sell to break even. That’s the difference between the number of units required to meet a profit goal and the required units that must be sold to cover the expenses.