Fixed vs. Variable Costs: How to Compute Breakeven
Breakeven analysis can be helpful when analyzing the effects of a cost reduction plan, investing in new equipment, or launching a new product. Calculating the breakeven point is pretty straightforward as you apply basic information from your company’s income statement. Here are the fine points.
Analyzing your costs
Breakeven can be understood in several ways. When total sales equal total expenses, you have a breakeven point. More precisely, it’s where net income is equal to zero and sales are equal to variable costs plus fixed costs.
Before you can measure your breakeven point, it’s helpful to grasp a few terms:
The expenses that remain mostly unchanged, despite changes in your business volume, are considered “fixed.” Examples: salaries, insurance, property taxes and depreciation.
These expenses fluctuate due to sales volume. If you had no sales revenue, you’d have no variable expenses and your semifixed expenses would be lower. Examples: supplies, materials, shipping costs, training and advertising.
The basic formula for calculating the breakeven point is:
Breakeven = fixed expenses / 1 – (variable expenses / sales).
You can calculate breakeven on many levels. If you have requisite sales and cost data broken down, you can estimate it for the company overall or by product line or division.
To illustrate, let’s suppose Division A generates $12 million in revenue, has fixed costs of $1 million and variable costs of $10.8 million. Here’s how those numbers fit into the breakeven formula:
Annual breakeven = $1 million / 1 – ($10.8 million / $12 million) = $10 million
Monthly breakeven = $10 million / 12 = $833,333
While expenses stay within budget, the breakeven point is reliable. In the illustration above, variable expenses must stay at 90% of revenue and fixed expenses must remain at $1 million. Should either of these variables shift, the breakeven point will shift, as well.
Breakeven analysis is useful for businesses when preparing budgets and setting revenue goals. The breakeven point can also help you identify the number of incremental sales you will need to recoup an investment, like hiring a new sales representative or purchasing a new machine. Breakeven works to help gauge the effects of cost reduction plans. Contact JLK Rosenberger at 972-931-6803 if you have questions or need help working through the calculations. You can also click here and we will contact you.