Break-even analysis

A break-even analysis is the sales level that is required for your business to operate without
incurring a financial loss. It is important to determine this point, as the viability of your business
is reliant on staying above this number.

A sample Break-Even Analysis

Let’s take a look at ALI’s Beach Umbrella Store, a retail hut that sells beach umbrellas. ALI
buys his umbrellas from the manufacturer for $10 and sells them for $20, making a gross profit
of $10 on each umbrella.

Gross Profit Formula

Sales Price / Cost of Goods Sold = Gross Profit

$20 / $10 = $10 per umbrella

Gross profit is the profit he makes after subtracting the costs of the item that he is selling,
excluding general expenses of running the business. So, in ALI’s case, the direct cost is the $10
he pays per umbrella to the manufacturer. The indirect costs or overhead costs would be the costs
of running the store. So, his direct cost of buying the umbrella will fluctuate based on how many
umbrellas he sells, whereas his indirect costs will remain fixed. The costs of buying umbrellas
are variable costs.

ALI is the only employee and pays himself no salary. ALI figures he doesn’t need to advertise
because his retail hut is located across the street from a busy beach. ALI’s only expense is his
rent of $2,000 per month, which also includes the electricity to power the one light bulb in his
hut. ALI only takes cash for sales.
ALI determines his break-even cost by starting with his fixed cost of $2,000 per month. Then he
divides that by the gross profit of $10 that he makes on the sale of each umbrella. So, his break-
even in terms of unit sales is $2,000 divided by $10, or 200 umbrellas per month.

Break-Even Formula

Fixed Cost / Gross Profit per Unit = Break-Even in Units

$2,000 / $10 = 200 Units (Umbrellas)

Since break-even is often thought of in terms of units of items sold, his sales break-even would
be 200 umbrellas. He could also think of his break-even in terms of total sales: 200 umbrellas
multiplied by $20, which would be $4,000.

Break-Even Formula in Sales $

(Fixed Cost / Gross Profit per Unit) x Sales Price per Unit =

Break Even Sales $

($2,000 / $10) x ($20) = $4,000

If ALI’s sales are fewer than 200 umbrellas (or $4,000) per month, he is losing money—he
would lose $10 for every umbrella sold. But, if his sales are greater than $4,000 per month, he is
making a profit—$10 for every 200+ umbrellas that he sells each month.

A break-even analysis helps you determine whether your overhead is realistic or needs to be
reduced. Maybe for ALI’s Beach Umbrella Store it is impossible to sell more than 190 umbrellas
in a month. If that is the case, then the fixed cost of $2,000 per month is too high for his business
model and ALI needs to make some changes—negotiate a lower rent, add an additional product
line, or move to a new beach!