It’s important, particularly for start-up companies, to understand the level of sales volume that they need to achieve in order to be financially viable. That level is the breakeven sales level. A breakeven sales level occurs when sales are exactly equal to total costs – no profit and no loss.
Obviously, your objective is to make a profit, not just break even. However, determining your breakeven sales level is often an important step to understanding the potential of your business.
The key to determining the breakeven sales level is determining, as accurately as possible, which of your expenses are fixed and which are variable. All expenses must be classified as one or the other, or allocated if they are semi-variable.
Fixed Expenses: These are expenses that are incurred independent of production or sales volume. Examples are rent, insurance, supervision, indirect labor, depreciation, property taxes, legal, accounting, telephone, etc. For manufacturing companies, cost of goods sold usually includes some fixed expenses.
Variable Expenses: These are expenses that vary with production and sales. Examples of variable expenses included in cost of goods sold are direct labor, materials and supplies. Variable expenses included among selling, general and administrative expenses might include promotional expenses, credit card fees, etc.
Once a sales amount is estimated we can perform the breakeven calculations. See SCORE 4.13.01.xlsx for a spreadsheet that can help you in your calculations. Here is an example:
Joe's candle makers wholesales cases of candles for $1,000. His goal is to sell 50 cases a month, i.e., $50,000 sales per month. Joe has calculated that his fixed expenses are $24,000 and that, at the expected sales level, variable expenses would be $15,000. After introducing the concept of the contribution margin we can calculate breakeven sales:
Contribution margin (CM) is the amount of each sales dollar that remains after the variable costs are subtracted. In Joe's case, this would be $50,000 - $15,000. The remaining percentage represents the amount contributed toward covering fixed expenses and generating profit. The CM is calculated as follows:
CM = Sales-Variable Expenses = $50,000-$15,000 = 70% of Sales
Now we can calculate the Breakeven Sales Level:
Breakeven Sales = Fixed Expenses/Contribution Margin (%) = $24,000/70% = $34,286
It is often useful to compare three levels of sales estimates, and the breakeven level generated as shown in the table below.
|Pessimistic % of sales||Breakeven % of sales||Expected % of sales||Optimistic % of sales|
|Sales||$25,000 100%||$34,286 100%||$50,000 100%||$60,000|
|Fixed Expenses||($24,000) 96%||($24,000) 70%||($24,000) 48%||($24,000)|
|Variable Expenses||($7,500) 30%||($10,286) 30%||($15,000) 30%||($18,000)|
|Gross Profit||($6,500) -26%||$0 0%||$11,000 22%||$18,000|
|Contribution Margin ($)|
|Sales-Variable Expenses||$17,500 70%||$24,000 70%||$35,000 70%||$42,000|
|Breakeven Sales =|
|Fixed Expenses/CM (%)||$34,286||$34,286||$34,286||$34,286|
Note that fixed expenses stay fixed across the estimates, while variable expenses vary by level of sales. Breakeven is the same at any level of sales.
For the optimistic case (Joe's goal) there is a 22% gross profit. At the breakeven level gross profit is 0 because expenses just meet the sales level. Below breakeven sales, of course, losses are incurred.
Data for the chart is as follows:
Sales: $25,000 $34,286 $50,000 $60,000
Fixed Expenses $24,000 $24,000 $24,000 $24,000
Variable Expenses $7,500 $10,286 $15,000 $18,000
Total Expenses $31,500 $34,286 $39,000 $42,000
Note that breakeven is where the total expenses line intersects sales
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