How to calculate break even sales
/Break even sales is the dollar amount of revenue at which a business earns a profit of zero. This sales amount exactly covers the underlying fixed expenses of a business, plus all of the variable expenses associated with the sales. It is useful to know the break even sales level, so that management has a baseline for the minimum amount of sales that must be generated in each reporting period to avoid incurring losses. For example, if a business downturn is expected, the break even level can be used to pare back fixed expenses to match the expected future sales level.
To calculate break even sales, divide all fixed expenses by the average contribution margin percentage. Contribution margin is sales minus all variable expenses, expressed as a percentage. The formula is:
Fixed expenses ÷ Contribution margin percentage = Break even sales
Example of the Break Even Sales Calculation
ABC International routinely incurs $100,000 of fixed expenses in each month. The company's contribution margin is 50%. This means that the business reaches a break even sales level at $200,000 of sales per month.
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Problems with Break Even Sales
There are some issues to be aware of before relying upon the break even sales concept. They are noted below.
Variable Contribution Margin
The contribution margin may not always be the same from month to month. If a company sells a different mix of products each month and those products all have different margins, then the resulting blended margin for the entire business will probably change. This is especially the case when some sales are seasonal, which will alter the mix of products being sold from month to month. Under these circumstances, the break even sales level will change over time, perhaps to such an extent that it does not give management any actionable information.
Historical Basis
The fixed expenses figure in the numerator of the formula is based on historical fixed expenses. For planning purposes, be sure to use an estimate of what fixed expenses are expected to be during the planning period, since these expenses may differ from the historical number. The fixed expense figure is especially difficult to derive for a new or rapidly-growing business, since these expenses will be changing constantly.