The break-even point (BEP) is one of the most important and fundamental calculations a business needs to establish.
Simply put it’s the point at which sales and costs are equal, meaning there is no loss or gain to the business. Without an understanding of break-even point business owners are at risk of making poor decisions which could ultimately lead to loss making activities.
How to calculate BEP
BEP = (Fixed costs + Director costs) / Gross profit margin
To understand break-even point you need to be able to calculate 2 figures:
- Gross profit %
- Fixed costs
For those business owners who take dividends by way of remuneration, we’ll also need:
- Directors dividends
- Corporation tax rates
We’ll work through an example in this FAQ…
Gross profit %
This is the return on sales after those costs directly relating to sales and is calculated as:
(Sales-cost of goods sold)/sales x100
For a business of sales with 1m and costs of 600k the gross profit % would be
1,000,000-600,000 = 400,000
400,000/1,000,000 = 40%
Fixed costs
Fixed costs are all the business costs that are likely to be incurred regardless of sales output. For example, the office rent is due for payment whether the business makes zero sales or 1m sales. Other examples include rates, light and heat and administrative staff.
We’ve discussed in other FAQ’s the importance of budgets and how these are a good source of identifying the fixed costs.
For the purpose of our example we’ll assume fixed costs are 250k
Directors costs
Ordinarily directors payroll costs will be incorporated into the fixed costs above. Where dividends are received we need to add a further calculation to account for the corporation tax. Dividends are a post tax payment and therefore in order to pay a dividend we first need to gross it up for corporation tax.
For example, if the corporation tax rate is 25% and the directors dividend is 75k our true fixed cost divided is:
75,000/(1-25%) → 75,000/0.75 = 100k
Putting it all together
Now we have worked through all the data we need we are in a position to calculate the break-even point. The formula is:
BEP = (Fixed costs + Director costs) / Gross profit margin
Using our example above the break-even point would be:
(250,000+100,000)/40% = £875k