The break-even point is achieved when a company’s total costs equal its total revenue.
The break-even point is calculated by dividing the company’s Indirect costs by its gross margin. Indirect costs are costs not directly associated with production. When sales are higher than the break-even point, the company has a profit; when sales are lower than the break-even point, there is a loss.
Dividing indirect costs by gross margin provides the break-even point in dollars. Dividing that number by the price per unit provides the break-even point in units sold.
Knowing the break-even point is important for a business because it establishes a threshold for success and helps set clear sales targets. A break-even analysis reveals how the break-even point changes when adjustments are made to the unit selling price.
More about the break-even point
The income statement below shows that ABC Co. earned $100,000 in revenue by selling 10,000 units at $10 per unit. The gross margin is 65% and the company’s indirect costs are $25,000.
In dollars, the break-even point is:
$25,000 / 65% = $38,461
Once the company reaches this level of sales, it has broken even.
In units, the break-even point is:
$38,461 / $10 = 3,846
Once the company sells this many units it has broken even.