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Most companies in operation desire a profit on business activities, whether the activities involve selling goods or services. A common formula for determining how much revenue is necessary to stay in business is the break-even point in sales. The basic formula for this measure divides a company’s weekly fixed expenses by the contribution margin per unit, which results in the total units to sell in order to cover all basic expenses. The break-even point in sales may also produce a dollar figure that a company needs to earn in order to break even. This latter formula divides weekly fixed expenses by the contribution margin ratio to produce the weekly dollar sales to break even.
A break-even point in sales is a primary beginning figure for determining the profitability of a project or individual product. Owners and executives often use this formula to assess how many units or dollars their company needs to sell in a given market. After computing the break-even computation, owners and executives can determine if reaching this sales point is possible under current economic conditions. For example, if a company has to sell 350 units of a particular product, then the business must find markets in which this is possible. Failure to reach this break-even point results in lost profits.
The basic break-even points in the sales formula mentioned above is dividing weekly fixed expenses by the contribution margin per unit. Weekly fixed expenses are the only included costs as companies must pay these costs regardless of whether or not a company produces goods or services. The contribution margin subtracts the per-unit variable costs for producing a good or service from the per-unit sales price for the good or service. The result is the contribution margin per unit. Variable costs should only occur when a company actually produces products, which is why the contribution margin ratio includes the costs in its formula.
The contribution margin ratio in the break-even point in sales is a different formula. This formula divides the contribution margin by the per-unit sales price. Once a company has this ratio computed, it can then divide weekly fixed expenses by the result in order to determine the dollar amount of weekly sales to cover fixed costs. This formula works best for a company that has a broad sales mix, that is, multiple products it manufactures for sale to consumers. Under this scenario, it is more important to know sales dollars rather than units in order to determine the break-even point in sales.