About Brian DeChesare
Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.
The Breakeven Formula and the Breakeven Point: Definition and Real-World Examples
The Breakeven Formula, defined as Fixed Costs / (Selling Price per Unit – Variable Cost per Unit), tells you the Breakeven Point, or the number of units that a company needs to sell to fully cover its fixed and variable costs associated with a product; after this point, any product sales translate directly into profit.
Breakeven Formula Definition: The Breakeven Formula, defined as Fixed Costs / (Selling Price per Unit – Variable Cost per Unit), tells you the Breakeven Point, or the number of units that a company needs to sell to fully cover its fixed and variable costs associated with a product; after this point, any product sales translate directly into profit.
Breakeven Point (in units) = Fixed Costs / (Selling Price per Unit – Variable Cost per Unit)
For example, let’s say a small business has $100,000 in fixed operating costs. These might include an employee’s salary, rent, utilities, and marketing expenses.
The company sells widgets for $50.00 each, and the variable cost associated with each one is $30.00.
This variable cost represents the Cost of Goods Sold (COGS) and might include parts, suppliers, raw materials, and labor required to manufacture the widget.
In this case, the Breakeven Point = $100,000 / ($50 – $30) = 5,000.
Therefore, this business must sell 5,000 widgets to cover its fixed costs in this period.
This makes intuitive sense because it earns a Gross Profit of $20, or $50 – $30, on each widget sold, and $20 * 5,000 = $100,000.
If this company now sells additional widgets beyond this 5,000, it is not all profit.
The COGS, or variable costs, still exist!
However, all its fixed expenses are paid, so the company earns a profit of $20 for each additional widget sold above 5,000 units.
The breakeven point is important for any business; before reaching it, all revenue covers its costs; after reaching it, revenue generated results in additional profits.
The Breakeven Point also indicates a company’s operational efficiency, pricing strategy, and overall financial health, especially when compared to similar companies in the same industry.
Files & Resources:
Breakeven Formula – Excel (XL)
Watches of Switzerland – Annual Report (PDF)
You can see an example of the Breakeven Point and the overall profits at different levels of units sold from this Excel file below:
The Breakeven Formula and the Contribution Margin
If you take the Selling Price per Unit, subtract the Variable Cost per Unit, multiply by the Units Sold, and divide by the Revenue in the period, you get the Contribution Margin:
This tells you the percentage of each unit’s selling price that can be used to cover fixed costs after the variable costs have been paid; it’s similar to the Gross Margin.
It’s 40% here because $20 = $50 – $30, and $20 / $50 = 40%.
If this Contribution Margin is higher, the company can afford to pay for more employees, rent, professional services, and anything else that is not directly linked to the number of units sold.
While the formula appears straightforward, note that it is a general representation that only sometimes works in real life.
Real businesses often have complex cost structures, varying prices, and multiple products.
Therefore, relying on this single formula might not always yield a complete or accurate picture.
The Breakeven Formula in Real Life: Watches of Switzerland
To illustrate the advantages and limitations of this breakeven formula in real life, let’s look at an example based on Watches of Switzerland, a luxury watch retailer based in Europe.
In its annual filings, it reports the following stats:
- Revenue: £1,542.8 million
- Variable Costs, or Revenue – Net Margin: £966.5 million
- Operating Expense (Fixed Costs): £576.3 – 165.1 = £411.2 million
We don’t know their exact selling prices or units sold, but based on the filings, they have an average selling price somewhere between £1,208 and £6,284:
(We’ll ignore the U.S. segment for simplicity and assume the ASP is about the same everywhere.)
Given that ~87% of their sales are from luxury watches, we’ll assume an ASP toward the top end of this range.
If we say the ASP is £5,000, this company sold approximately 300,000 units in this year based on this £1.5 billion in revenue.
The Variable Costs are £966.5 million, so the Variable Costs per Unit are £966.5 million / 300,000 units, or approximately £3,222.
Using the Breakeven Formula above:
Breakeven Point = Fixed Costs / (Selling Price per Unit – Variable Cost per Unit)
Breakeven Point = £411.2 million / (£5,000 – £3,222)
Breakeven Point = 231,271 units.
Therefore, Watches of Switzerland must sell at least 231,271 watches and jewelry pieces to break even and cover its fixed operating costs, such as employees, rent, and store opening and closing costs.
If the company sells beyond this, as in this most recent year, the additional unit sales all contribute to the company’s Operating Income, Pre-Tax Income, and Net Income (i.e., after-tax profits) for the year.
Limitations of the Breakeven Formula
This example also shows some of the limitations of this breakeven formula.
One big issue is that most large companies do not disclose their average selling price per unit across all their business segments.
We used some guesswork above to make an estimate, but this could be quite far off since we don’t have the overall average for the company.
Also, we ignored the regional split between Europe and the U.S., which could be quite significant if the ASPs differ by geography.
Another issue is that it’s not always clear what should be considered a fixed vs. variable cost, although there are general guidelines for the line items that tend to go into COGS (“Cost of Goods Sold”).
Finally, this breakeven formula is much more useful internally at a company when you have all the numbers, budgets, and unit economics by segment.
To external investors, so much guesswork is involved that the phrase “garbage in, garbage out” applies here.
The Breakeven Formula: Conclusion
The Breakeven Formula and Breakeven Point are useful for determining how close a startup or new company is to profitability and the sales volume required to achieve it.
For larger, mature firms, these concepts are useful mostly for benchmarking and comparing one company to its peers, as in comparable company analysis.
The biggest drawback is that most companies do not disclose enough data to the public to calculate the Breakeven Point accurately.
But if you have access to this data internally at a company or you are analyzing a firm that happens to give you the right information, these metrics can greatly enhance your operational analysis and benchmarking.
