Break-even Point

Let's say that the owner of Oil Change Co. needs to earn a profit of $1,200 per week rather than merely breaking even. You can consider the owner's required profit of $1,200 per week as another fixed expense. In other words the fixed expenses will now be $3,600 per week (the $2,400 listed earlier plus the required $1,200 for the owner). The new point needed to earn $1,200 per week is shown by the following break-even formula:

Always check your calculations:

Oil Change Co. Projected Net Income For a Week Sales (240 cars serviced at $24 per car) $ 5,760 Variable Expenses (240 cars at $9 per car) – 2,160 Contribution Margin 3,600 Fixed Expenses – 2,400 Net Income $ 1,200

The above schedule confirms that servicing 240 cars during a week will result in the required $1,200 profit for the week.

One can determine the break-even point in sales dollars (instead of units) by dividing the company's total fixed expenses by the contribution margin ratio.

The contribution margin ratio is the contribution margin divided by sales (revenues)
The ratio can be calculated using company totals or per unit amounts. We will compute the contribution margin ratio for the Oil Change Co. by using its per unit amounts:

Revenues or Sales per car $24 Variable Expenses per car –  9 Contribution Margin per car $15

The break-even point in sales dollars for Oil Change Co. is:

The break-even point of $3,840 of sales per week can be verified by referring back to the break-even point in units. Recall there were 160 units necessary to break-even. At $24 per unit the necessary sales in dollars would be $3,840.

Let's assume a company needs to cover $2,400 of fixed expenses each week plus earn $1,200 of profit each week. In essence the company needs to cover the equivalent of $3,600 of fixed expenses each week.

Presently the company has annual sales of $100,000 and its variable expenses amount to $37,500 per year. These two facts result in a contribution margin ratio of 62.5%:

Sales $100,000 Variable Expenses – 37,500 Contribution Margin $ 62,500

The amount of sales necessary to give the owner a profit of $1,200 per week is determined by this break-even point formula:

To verify that this answer is reasonable, we prepared the following schedule:

Per Week 52 Weeks Sales $ 5,760 $ 299,520 Variable Expenses (37.5%) – 2,160 – 112,320 Contribution Margin 3,600 187,200 Fixed Expenses – 2,400 – 124,800 Profit $ 1,200 $   62,400

As you can see, for the owner to have a profit of $1,200 per week or $62,400 per year, the company's annual sales must triple. Presently the annual sales are $100,000 but the sales need to be $299,520 per year in order for the annual profit to be $62,400.

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Because the material covered here is considered an introduction to this topic, many complexities have been omitted. You should always consult with an accounting professional for assistance with your own specific circumstances.

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