In economics, the term “break-even” refers to a point at which an enterprise's costs equal its revenues. At the break-even point, profit is equal to zero, and any revenue made above this point will contribute to profits. Understanding the break-even point in any operation is critically important, as it calculates the minimum amount of revenue that must be made to meet costs.
A break-even analysis may be performed to determine at what point costs will equal revenues. Performing this type of analysis can not only give a business, household, or even government a level of revenue to shoot for, but can also impact a variety of decisions, from order size to sale price. Without having clear data about the moment in which revenues and costs equalize, an organization may never truly know whether they are in the money, or in the red.
To calculate the break-even point, clear data on costs and revenues must be gathered. In terms of costs, there are generally two categories: fixed and variable. Fixed costs include things that are exactly the same amount each cost-cycle, such as monthly rent on a storefront. Variable costs are those that may fluctuate up and down, such as utility costs. In a manufacturing business, fixed costs might include the price of materials per unit, while a variable cost might be employee payroll once overtime is considered.
Revenues are based on the amount of goods or services sold and the price at which they are sold. If a spa employee gives 10 haircuts at $45 US Dollars (USD), five manicures at $20 USD, and four pedicures at $15 USD in a week, his or her weekly revenue will be (10X45)+(5X20)+(4X15), or $610 USD. Generally, however, an analysis is done without data on how many units have been sold; it is the point of most analyses to determine how many units need to be sold at current prices to match costs. Therefore, if the hairdresser's weekly costs were $400 USD, he or she would need to sell a combination of haircuts, manicures, and pedicures that matched or exceeded that amount. If his or her total revenues consistently fall below total cost levels, he or she would need to consider either lowering costs or raising prices.
Unfortunately, lowering costs or raising prices cannot always bring about an exact change to profit margins. If the hairdresser raises prices too far, he or she may lose clients who are unwilling to pay the premium. Lowering costs could mean providing a lower-quality product, which can erode customer support and loyalty. Often, businesses must develop hybridized strategies that allow them to still provide a good product while not overcharging clients; reaching the break-even point may be the result of a series of incremental changes rather than one big swooping strategical shift.
