{"id":29067,"date":"2024-05-09T20:16:21","date_gmt":"2024-05-10T01:16:21","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/?post_type=biws_kb&#038;p=29067"},"modified":"2024-10-09T06:14:29","modified_gmt":"2024-10-09T11:14:29","slug":"breakeven-formula","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/accounting\/breakeven-formula\/","title":{"rendered":"The Breakeven Formula and the Breakeven Point: Definition and Real-World Examples"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">The Breakeven Formula and the Breakeven Point: Definition and Real-World Examples<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/breakeven-formula\/#The_Breakeven_Formula_and_the_Contribution_Margin\">The Breakeven Formula and the Contribution Margin<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/breakeven-formula\/#The_Breakeven_Formula_in_Real_Life_Watches_of_Switzerland\">The Breakeven Formula in Real Life: Watches of Switzerland<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/breakeven-formula\/#Limitations_of_the_Breakeven_Formula\">Limitations of the Breakeven Formula<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/breakeven-formula\/#The_Breakeven_Formula_Conclusion\">The Breakeven Formula: Conclusion<\/a><\/li><\/ul><\/nav><\/div>\n\n<blockquote><p><strong>Breakeven Formula Definition:<\/strong> The Breakeven Formula, defined as Fixed Costs \/ (Selling Price per Unit \u2013 Variable Cost per Unit), tells you the <strong>Breakeven Point<\/strong>, or the number of units that a company needs to sell to fully cover its fixed and variable costs associated with a product; after this point, any product sales translate directly into profit.<\/p><\/blockquote>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29068 size-full\" title=\"Breakeven Formula Definition\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201348\/00-Breakeven-Formula-Definition.jpg\" alt=\"Breakeven Formula Definition\" width=\"2366\" height=\"230\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201348\/00-Breakeven-Formula-Definition.jpg 2366w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201348\/00-Breakeven-Formula-Definition-300x29.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201348\/00-Breakeven-Formula-Definition-1024x100.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201348\/00-Breakeven-Formula-Definition-768x75.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201348\/00-Breakeven-Formula-Definition-1536x149.jpg 1536w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201348\/00-Breakeven-Formula-Definition-2048x199.jpg 2048w\" sizes=\"(max-width: 2366px) 100vw, 2366px\" \/><\/p>\n<p><strong>Breakeven Point (in units)<\/strong> = Fixed Costs \/ (Selling Price per Unit \u2013 Variable Cost per Unit)<\/p>\n<p>For example, let\u2019s say a small business has $100,000 in fixed operating costs. These might include an employee\u2019s salary, rent, utilities, and marketing expenses.<\/p>\n<p>The company sells widgets for $50.00 each, and the variable cost associated with each one is $30.00.<\/p>\n<p>This variable cost represents the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/cogs\/\" target=\"_blank\" rel=\"noopener\">Cost of Goods Sold (COGS)<\/a> and might include parts, suppliers, raw materials, and labor required to manufacture the widget.<\/p>\n<p>In this case, the Breakeven Point = $100,000 \/ ($50 \u2013 $30) = 5,000.<\/p>\n<p>Therefore, this business must sell <strong>5,000 widgets <\/strong>to cover its fixed costs in this period.<\/p>\n<p>This makes intuitive sense because it earns a Gross Profit of $20, or $50 \u2013 $30, on each widget sold, and $20 * 5,000 = $100,000.<\/p>\n<p>If this company now sells additional widgets <em>beyond<\/em> this 5,000, it is not all profit.<\/p>\n<p>The COGS, or variable costs, still exist!<\/p>\n<p>However, all its fixed expenses are paid, so the company earns a profit of $20 for each additional widget sold above 5,000 units.<\/p>\n<p>The breakeven point is important for any business; before reaching it, all revenue covers its costs; after reaching it, revenue generated results in additional profits.<\/p>\n<p>The Breakeven Point also indicates a company\u2019s operational efficiency, pricing strategy, and overall financial health, especially when compared to similar companies in the same industry.<\/p>\n<h3>Files &amp; Resources:<\/h3>\n<p><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Accounting\/Breakeven-Formula\/Breakeven-Formula.xlsx\" target=\"_blank\" rel=\"noopener\">Breakeven Formula &#8211; Excel (XL)<\/a><\/p>\n<p><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Accounting\/Breakeven-Formula\/Watches-of-Switzerland.pdf\" target=\"_blank\" rel=\"noopener\">Watches of Switzerland \u2013 Annual Report (PDF)<\/a><\/p>\n<p>You can see an example of the Breakeven Point and the overall profits at different levels of units sold from this Excel file below:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29069 size-full\" title=\"Breakeven Formula - Excel Example\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201418\/01-Breakeven-Formula-Excel-Example.jpg\" alt=\"Breakeven Formula - Excel Example\" width=\"1382\" height=\"846\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201418\/01-Breakeven-Formula-Excel-Example.jpg 1382w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201418\/01-Breakeven-Formula-Excel-Example-300x184.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201418\/01-Breakeven-Formula-Excel-Example-1024x627.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201418\/01-Breakeven-Formula-Excel-Example-768x470.jpg 768w\" sizes=\"(max-width: 1382px) 100vw, 1382px\" \/><\/p>\n<h2><span class=\"ez-toc-section\" id=\"The_Breakeven_Formula_and_the_Contribution_Margin\"><\/span>The Breakeven Formula and the Contribution Margin<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>If you take the <strong>Selling Price per Unit<\/strong>, subtract the <strong>Variable Cost per Unit<\/strong>, multiply by the <strong>Units Sold<\/strong>, and divide by the <strong>Revenue<\/strong> in the period, you get the <strong>Contribution Margin:<\/strong><\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29070 size-full\" title=\"Contribution Margin Example\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201439\/02-Contribution-Margin.jpg\" alt=\"Contribution Margin Example\" width=\"784\" height=\"720\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201439\/02-Contribution-Margin.jpg 784w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201439\/02-Contribution-Margin-300x276.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201439\/02-Contribution-Margin-768x705.jpg 768w\" sizes=\"(max-width: 784px) 100vw, 784px\" \/><\/p>\n<p>This tells you the <strong>percentage of each unit\u2019s selling price<\/strong> that can be used to cover fixed costs after the variable costs have been paid; it&#8217;s similar to the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/gross-margin\/\" target=\"_blank\" rel=\"noopener\">Gross Margin<\/a>.<\/p>\n<p>It\u2019s 40% here because $20 = $50 \u2013 $30, and $20 \/ $50 = 40%.<\/p>\n<p>If this Contribution Margin is higher, the company can afford to pay for more employees, rent, professional services, and anything else that is <em>not<\/em> directly linked to the number of units sold.<\/p>\n<p>While the formula appears straightforward, note that it is a general representation that only sometimes works in real life.<\/p>\n<p>Real businesses often have complex cost structures, varying prices, and multiple products.<\/p>\n<p>Therefore, relying on this single formula might not always yield a complete or accurate picture.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"The_Breakeven_Formula_in_Real_Life_Watches_of_Switzerland\"><\/span>The Breakeven Formula in Real Life: Watches of Switzerland<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>To illustrate the advantages and limitations of this breakeven formula in real life, let\u2019s look at an example based on <strong>Watches of Switzerland<\/strong>, a luxury watch retailer based in Europe.<\/p>\n<p>In its annual filings, it reports the following stats:<\/p>\n<ul>\n<li><strong>Revenue:<\/strong> \u00a31,542.8 million<\/li>\n<li><strong>Variable Costs<\/strong>, or <strong>Revenue \u2013 Net Margin:<\/strong> \u00a3966.5 million<\/li>\n<li><strong>Operating Expense (Fixed Costs):<\/strong> \u00a3576.3 \u2013 165.1 = \u00a3411.2 million<\/li>\n<\/ul>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29071 size-full\" title=\"Swiss Watches - Data for Breakeven Point\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201518\/03-Swiss-Watches-Data.jpg\" alt=\"Swiss Watches - Data for Breakeven Point\" width=\"1068\" height=\"894\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201518\/03-Swiss-Watches-Data.jpg 1068w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201518\/03-Swiss-Watches-Data-300x251.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201518\/03-Swiss-Watches-Data-1024x857.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201518\/03-Swiss-Watches-Data-768x643.jpg 768w\" sizes=\"(max-width: 1068px) 100vw, 1068px\" \/><\/p>\n<p>We don\u2019t know their exact selling prices or units sold, but based on the filings, they have an average selling price somewhere between \u00a31,208 and \u00a36,284:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29072 size-full\" title=\"Swiss Watches - Average Selling Prices (ASPs)\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201556\/04-Swiss-Watches-ASP.jpg\" alt=\"Swiss Watches - Average Selling Prices (ASPs)\" width=\"448\" height=\"825\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201556\/04-Swiss-Watches-ASP.jpg 448w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/09201556\/04-Swiss-Watches-ASP-163x300.jpg 163w\" sizes=\"(max-width: 448px) 100vw, 448px\" \/><\/p>\n<p>(We\u2019ll ignore the U.S. segment for simplicity and assume the ASP is about the same everywhere.)<\/p>\n<p>Given that ~87%\u00a0 of their sales are from luxury watches, we\u2019ll assume an ASP toward the top end of this range.<\/p>\n<p>If we say the ASP is \u00a35,000, this company sold approximately 300,000 units in this year based on this \u00a31.5 billion in revenue.<\/p>\n<p>The Variable Costs are \u00a3966.5 million, so the Variable Costs per Unit are \u00a3966.5 million \/ 300,000 units, or approximately \u00a33,222.<\/p>\n<p>Using the Breakeven Formula above:<\/p>\n<p>Breakeven Point = Fixed Costs \/ (Selling Price per Unit &#8211; Variable Cost per Unit)<\/p>\n<p>Breakeven Point = \u00a3411.2 million \/ (\u00a35,000 \u2013 \u00a33,222)<\/p>\n<p>Breakeven Point = 231,271 units.<\/p>\n<p>Therefore, <strong>Watches of Switzerland<\/strong> must sell at least 231,271 watches and jewelry pieces to break even and cover its fixed operating costs, such as employees, rent, and store opening and closing costs.<\/p>\n<p>If the company sells beyond this, as in this most recent year, the additional unit sales all contribute to the company\u2019s <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/ebit-operating-income\/\" target=\"_blank\" rel=\"noopener\">Operating Income<\/a>, Pre-Tax Income, and <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/net-income\/\" target=\"_blank\" rel=\"noopener\">Net Income<\/a> (i.e., after-tax profits) for the year.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Limitations_of_the_Breakeven_Formula\"><\/span>Limitations of the Breakeven Formula<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>This example also shows some of the <strong>limitations<\/strong> of this breakeven formula.<\/p>\n<p>One big issue is that <strong>most large companies do not disclose their average selling price per unit<\/strong> across all their business segments.<\/p>\n<p>We used some guesswork above to make an estimate, but this could be quite far off since we don\u2019t have the overall average for the company.<\/p>\n<p>Also, we ignored the regional split between Europe and the U.S., which could be quite significant if the ASPs differ by geography.<\/p>\n<p>Another issue is that it\u2019s not always clear what should be considered a fixed vs. variable cost, although there are general guidelines for the line items that tend to go into <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/cogs\/\" target=\"_blank\" rel=\"noopener\">COGS (\u201cCost of Goods Sold\u201d)<\/a>.<\/p>\n<p>Finally, this breakeven formula is much more useful <strong>internally<\/strong> at a company when you have all the numbers, budgets, and unit economics by segment.<\/p>\n<p>To external investors, so much guesswork is involved that the phrase \u201cgarbage in, garbage out\u201d applies here.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"The_Breakeven_Formula_Conclusion\"><\/span>The Breakeven Formula: Conclusion<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The Breakeven Formula and Breakeven Point are useful for determining how close a startup or new company is to profitability and the sales volume required to achieve it.<\/p>\n<p>For larger, mature firms, these concepts are useful mostly for <strong>benchmarking<\/strong> and comparing one company to its peers, as in <a href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/comparable-company-analysis-cca\/\" target=\"_blank\" rel=\"noopener\">comparable company analysis<\/a>.<\/p>\n<p>The biggest drawback is that most companies do not disclose enough data to the public to calculate the Breakeven Point accurately.<\/p>\n<p>But if you have access to this data internally at a company or you are analyzing a firm that happens to give you the right information, these metrics can greatly enhance your operational analysis and benchmarking.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The Breakeven Formula, defined as Fixed Costs \/ (Selling Price per Unit \u2013 Variable Cost per Unit), tells you the Breakeven Point, or the number of units that a company needs to sell to fully cover its fixed and variable costs associated with a product; after this point, any product sales translate directly into profit.<\/p>\n","protected":false},"featured_media":29361,"template":"","class_list":["post-29067","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-accounting"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/29067","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/29361"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=29067"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}