If you’re a business owner, you should know how to do a break-even analysis. It’s an important thing for making important business decisions and financial planning.

Break even analysis is a small business accounting process for determining at what point a company, or a new product or service, will be profitable. It’s a financial calculation used to determine the number of products or services you need to sell to at least cover your production costs.

For example, a break-even analysis could help you determine how many cellphone cases you need to sell to cover your warehousing costs. Or how many hours of service you need to sell to pay for your office space. Anything you sell beyond your break-even point will add profit.

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There are a few definitions you need to know in order to understand break-even analysis:

Fixed costs: expenses that stay the same no matter how much you sell.
Variable costs: expenses that fluctuate up and down with production or sales volume.

The break-even theory is based on the fact that there is a minimum product level at which a venture neither makes profit nor loss.

Benefits of Break-Even Analysis

Better price. Finding your break-even point will help you understand how to price your products better. A lot of psychology goes into effective pricing, but knowing how it will affect your gross profit margins is just as important. You need to make sure you can pay your bills.
Cover fixed costs. When most people think about pricing, they think about how much their product costs to create—these are considered variable costs. You still need to cover your fixed costs, like insurance or web development fees. Doing a break-even analysis helps you do that.
Identify missing expenses. It’s easy to forget about expenses when you’re thinking through a small business idea. When you do a break-even analysis you have to lay out all your financial commitments to figure out your break-even point. This will limit the number of surprises down the road.
Sales revenue targets. After completing a break-even analysis, you know exactly how much you need to sell to be profitable. This will help you set more concrete sales goals for you and your team. When you have a clear number in mind, it will be much easier to follow through.
Attracts funds for business. A break-even analysis is a key component of any business plan. It’s usually a requirement if you want to take on investors or other debt to fund your business. You have to prove your plan is viable. More than that, if the analysis looks good, you will be more comfortable taking on the burden of financing.

What Is Break-Even Point and How to Calculate It

Your break-even point is equal to your fixed costs, divided by your average selling price, minus variable costs. It is the point at which revenue is equal to costs and anything beyond that makes the business profitable.

Formula: break-even point = fixed cost / (average selling price – variable costs)

Basically, you need to figure out what your net profit per unit sold is and divide your fixed costs by that number. This will tell you how many units you need to sell before you start earning a profit.

As you now know, your product sales need to pay for more than just the costs of producing them. The remaining profit is known as the contribution margin ratio because it contributes sales dollars to the fixed costs.

Now that you know what it is, how it works, and why it matters, let’s break down how to calculate your break-even point.

Before we get started, get your free copy of the break-even analysis template here by Shopify. After you make a copy, you’ll be able to edit the template and do your own calculations. Example of the template as below:

When to Use Break-Even Analysis

1. Starting A New Business

If you’re thinking about starting a new business, a break-even analysis is a must. Not only will it help you decide if your business idea is viable, but it will force you to do research and be realistic about costs, and make you think through your pricing strategy.

2. Launching A New Product

If you already have a business, you should still do a break-even analysis before committing to a new product—especially if that product is going to add significant expense. Even if your fixed costs, like an office lease, stay the same, you’ll need to work out the variable costs related to your new product and set prices before you start selling.

3. New Sales Channel

Any time you add a new sales channel, your costs will change—even if your prices don’t. For example, if you’ve been selling online and you’re thinking about doing a pop-up shop, you’ll want to make sure you at least break even. Otherwise, the financial strain could put the rest of your business at risk.

This applies equally to adding new online sales channels, like shoppable posts on Instagram. Will you be planning any additional costs to promote the channel, like Instagram ads? Those costs need to be part of your break-even analysis.

New or Modified Business Model

If you’re thinking about changing your business model, for example, switching from dropshipping products to carrying inventory, you should do a break-even analysis. Your startup costs could change significantly, and this will help you figure out if your prices need to change too.

Final Thoughts

It’s important to note that a break-even analysis is not a predictor of demand. It won’t tell you what your sales are going to be or how many people will want what you’re selling. The break-even analysis ignores fluctuations over time. The time frame will be dependent on the period you use to calculate fixed costs (monthly is most common). Although you’ll see how many units you need to sell over the course of the month, you won’t see how things change if your sales fluctuate week to week, or seasonally over the course of a year. For this, you’ll need to rely on good cash flow management, and possibly a solid sales forecast.

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