## How to Create a Break-Even Point

After completing your Financial Budgets (step 1), your First Year Forecasted Cash Flow Statement (step 2), your First Year Forecasted Income Statement (step 3), your First Year Forecasted Balance Sheet (step 4), and your First Year Forecasted Ratios (step 5), the next step is to develop your First Year Forecasted Break-even Point (remember to create your forecasted financial statements and analysis one year at a time).

Recall from previous discussions, a Break-even Analysis, in its simplest form, is a tool used to determine the level of sales a business must earn in order to achieve neither a profit nor a loss. In other words, the Break-even Analysis determines the number of units or products a company must sell in order to achieve a Net Income of ZERO (revenues - expenses = \$0.00).

The formula used to calculate your Break-even Point is as follows:

Break-even in Units  =                           F ixed Costs
Selling Price per unit - Variable Costs per unit

Notice three (3) components are required in the formula; namely, Selling Price per unit, Variable Costs per unit, and Fixed Costs.

Your Selling Price per unit is the price you plan to sell your product for. If you plan to sell more than one type of product, you will be required to determined a Weighted Average Selling Price. The weighted average selling price would, in turn, be used in the formula to determine the Break-even Point. At any rate, you should have already determined your selling price per unit or weighted average selling price in Budget 1 entitled "Determining Your Selling Price and Product Cost (per unit)".

Recall from our example that Murray plans to sell each diskette (unit) for \$26.00 in 200X and \$24.00 in 200Y. As a result, his \$26.00 selling price per unit will be used in the formula to calculate his 200X Break-even Point, while his \$24.00 selling price per unit will be used in the formula to calculate his 200Y Break-even Point. (Please Note: the Selling Price, used in the break-even formula, MUST be valued on a per unit basis).

Variable Costs are costs or expenses that fluctuate with production or sales. The most common variable cost is a company's Total Product Cost per unit. A retailer or service provider's Total Product Cost per unit simply consists of the cost to purchase each product and the cost to ship each product to the company's place of business. A manufacturer's Total Product Cost per unit consists of the cost to purchase enough raw materials to make one finished product, the cost to ship the raw materials to the manufacturer's place of business, the cost of direct labor needed to make one finished unit, and factory overhead to make one finished unit.

If you plan to sell more than one product, you will be required to determine a Weighted Average Product Cost. The weighted average product cost would, in turn, be used in the formula to determine the Break-even Point.

At any rate, a retailer or service provider would have already determined its Total Product Cost per unit OR its Weighted Average Product Cost in Budget 1 entitled "Determining Your Selling Price and Product Cost (per unit)".

A manufacturer, on the other hand, would use Budget 1 entitled "Determining Your Selling Price and Product Cost (per unit)", Budget 4 entitled "Developing Your Direct Manufacturing Labor Budget", and Budget 5 entitled, "Developing Your Manufacturing Factory Overhead Budget" in order to determine its Total Product Cost per unit OR its Weighted Average Product Cost.

Recall from our example, Murray's total cost to purchase each diskette (unit) and have it shipped to his place of business (IE Total Product Cost per Unit) is expected to be \$3.00 in 200X and \$3.30 in 200Y. Since Murray's Total Product Cost is considered his only Variable Cost, \$3.00 will be used in the formula to calculate his 200X Break-even Point and \$3.30 will be used in the formula to calculate his 200Y Break-even Point. (Please Note: the Variable Cost used in the break-even formula MUST be valued on a per unit basis.

Fixed Costs are costs or expenses that do NOT fluctuate with production or sales. Most companies consider each Operating Expense a Fixed Cost (IE all marketing & administrative expenses are considered fixed costs). Unlike, the selling price and the variable cost, the break-even formula does NOT require Fixed Costs to be calculated on a per unit basis. Therefore, in most cases, companies can simply refer back to Budget 9 entitled "Developing Your Operating Expense Budget" for their Fixed Costs.

Below summarizes Murray's Operating Expenses and hence, his Fixed Costs.

 200X 200Y Total Marketing Expense \$37,998 \$48,998 Total Administrative Expense \$46,173 \$92,100 Total Operating Expense/Fixed Costs \$84,171 \$141,098

As you can see, Murray's Total Fixed Costs for 200X and 200Y is forecasted at \$84,171 and 141,098 respectively. As a result, his \$84,171 in Fixed Costs will be used in the formula to calculate his 200X Break-even Point and his \$141,098 in Fixed Costs will be used in the formula to calculate his 200Y Break-even Point.

Now Murray has enough information to calculate his Forecasted Break-even Point for 200X and 200Y.

Scholarship Information Services
Break-even Point
For Years 200X and 200Y

Break-even in Units  =                           F ixed Costs
Selling Price per unit - Variable Costs per unit

200X                      200Y

___Total Fixed Costs______      =     \$84,171           \$141,098
Selling Price - Variable Costs            \$23.00             \$20.70

Break-even in Units per Year   =       3,660 units          6,816 units

Therefore, Murray must sell 3,660 diskettes (units) in 200X in order to break-even. Said another way, Murray must sell 3,660 diskettes in order to achieve a Net Income Before Taxes of \$0.00. Each unit sold above the Break-even Point in 200X will produce a full profit of \$23.00 (selling price per unit - variable cost per unit). Therefore, if in 200X Murray sells 1,000 units above his break-even point or 4,660 diskettes (IE 3,660 +1,000 = \$4,660 diskettes), he would have a Net Income Before Tax of \$23,000 (1,000 diskettes x \$23.00 made from each diskette sold).

In 200Y, Murray must sell 6,816 diskettes (units) in order to break-even. Said another way, Murray must sell 6,816 diskettes in order to achieve a Net Income Before Taxes of \$0.00. Any unit sold above the Break-even Point in 200Y will produce a full profit of \$20.70 (200Y's selling price per unit - 200Y's variable cost per unit). Therefore, if in 200Y, Murray sells 1,000 units above his break-even point or 7,816 diskettes (IE 6,816 +1,000 = \$7,816 diskettes), he would have a Net Income Before Tax of \$20,700 (1,000 diskettes x \$20.70 made from each diskette sold during 200Y).

Below summaries the Budgets that need to be completed before you can develop your Forecasted Break-even Point.

 Budget Name Required to Determine Your Forecasted Determine Your Selling Price Selling Price per unit for each year Determine Your Total Product Cost Total Product Cost per unit for each year Operating Expenses Budget Total Operating Expenses per year (fixed costs)

Once again, if you plan to sell more than one type of product, you will be required to calculate a weighted average selling price and a weighted average product cost. These weighted averages will then be used in your Break-even Formula (shown below).

Break-even in Units  =                           F ixed Costs
Selling Price per unit - Variable Costs per unit