What is The Sales Break Even Point?
The sales break even point (SBEP) is the point at which the contribution margin and fixed costs (or expenses) are equal, in other words there is no net profit (loss or gain), and the business has what is called "broken even". A profit or a loss has not been made.
Establishing Break Even Sales
Calculating the sales break even point is one of the simplest and not often understood areas of business management. It helps to provide a view of the relationships between sales, fixed costs and profits.
A better understanding is to look at the chart below where a mini profit and loss report is shown, this chart clearly shows the relationship each category has to total sales (total sales being 100%). Showing the percentage to sales gives you an easier understanding of the numbers represented here.
Break Even Sales
In order to establish the sales break even point there are 3 key areas to understand, these are:
1. Direct Costs
In this calculation we need to consider the direct costs (sometimes called variable costs), these costs change in direct proportion to the sales. Over time in your business you will know what the average percentage to sales the direct costs are, so in any break even analysis if this changes then this will impact on the percentage contribution margin. Assuming that the direct cost percentage is 60% to sales (as in our above example) then our contribution margin will remain at 40%.
2. Contribution Margin
The contribution margin (or sometimes referred to as gross profit or gross margin) is the amount left over after the direct costs (sometimes called cost of sales or cost of goods sold) has been deducted from the sales (or revenue). This in the above example is shown to be $40,000 or 40% of sales = $40,000 divided by $100,000, (expressed as a percentage).
3. Fixed Costs
The fixed costs (or fixed expenses) do not change in relation to the amount of sales generated, in the above example our fixed costs are $30,000. These fixed costs remain at $30,000 regardless of whether are sales are $100,000 or $1,000.
Calculating Break Even Sales
From the above we can now calculate the sales break even point as follows:
1. We know that the fixed costs are $30,000.
2. We know that the contribution margin is 40%.
From this we make a simple calculation:
Fixed costs divided by contribution margin %
Therefore in the above scenario our break even sales are $75,000.
We can see the result in the chart below.
As you can see the break even point for sales of $75,000 results is a zero (0) net profit result. The direct costs are assumed to remain at 60% of sales and this percentage must still be applied to perform this calculation correctly.
To Force a Required Net Profit Result
When you want a desired level of net profit a further simple calculation can be performed. For example, assuming all of the above numbers remain the same, and the percentages to sales are the same, you now want to know what level of sales are required to achieve a certain amount of net profit.
Let's say we want to achieve $30,00 net profit,
The first part of the formula remains the same, except this time we add the $30,000 (required net profit) to the fixed costs of $30,000 and again divide this total ($60,000) by the contribution margin of 40% (or 0.4).
So for any given figure required for net profit we can simply add this to the fixed expenses and then divide this total by the contribution margin percentage and then we can calculate the required level of sales to achieve this.
The result of this calculation is shown in the chart below.
So you can see that you require sales of $150,000 to achieve a net profit of $30,000!
Whilst most of these calculations are usually performed with the original budget figures that were developed at the beginning of the trading (or financial) year, these numbers, ratios or percentages may change as you develop actual numbers for your business.
So be sure that when you perform the above calculations that you are dealing with the very latest data on your business. It would be best to take a reasonable period (say 3 months, or longer) and check the percentages to sales against what you had originally budgeted for, this then makes it real and the results of these calculations you can then use in your business model.