The BEP Formula – A Forecasting Primer

BEP  aka breakeven point is the revenue level at which a business or activity’s revenue equals its costs.  I like BEP a lot because business owners get it. It’s easy to manipulate, highly flexible and works for almost every business.  It’s simply a great tool for business forecasting and planning.  The best way to learn it is to use it so let’s go to an example.

Example:

Barry, a pencil manufacturer, is losing money and wants to know what’s his breakeven point or how much sales does he need to do to cover his costs?

Last year’s sales were 1,000,000 pencils at an average price of $0.50 or $500,000.  Barry sells all his pencils through outside reps who he pays 10% of sales as a commission. Barry’s costs were:

Materials cost              $100,000
Sales commissions      $  50,000
Rent                              $200,000
Utilities                        $  75,000
Salaries                       $300,000

Given the above costs, what’s his breakeven point (BEP)?

In order to calculate BEP you first you need to classify each cost as either fixed or variable.   Variable costs are costs that change with sales, ie if sales go up 10% they go up 10%.  If sales go down they too go down.  Fixed costs are those that don’t change based on the sales level, like rent.

The below classifies Barry’s costs between variable and fixed:

Pencils cost                $100,000    VC (variable cost)
Sales commissions     $  50,000    VC
Rent                             $200,000    FC (fixed cost)
Utilities                       $  75,000    FC
Salaries                       $300,000    FC

Since variable costs change with sales levels they’re generally calculated as a percentage of sales for purposes of the BEP formula.

Variable cost percentages:

Pencils cost                $100,000   ($100,000/$500,000 or 20%)
Sales commissions    $  50,000   ($  50,000/$500,000 or 10%)
Total Variable cost =    30%

Next total the fixed costs:

Rent                             $200,000
Utilities                        $  75,000
Salaries                        $300,000
Total Fixed cost          $575,000

We’re now ready to apply the BEP formula, BEP = FC/(1-VC)
Or
$575,000/(1-30%) or $575,000/.7

BEP = $821,429

Here’s the Proof

Revenues                                     $821,429
Less: Variable costs @30%      $246,429

=Contribution to Fixed cost     $575,000
Less: Fixed cost                          $575,000

=Profit (loss)                                    0

Barry tells me, that his plant could produce 2,000,000 pencils with the same salaries.  He asks, how much revenue would he need to breakeven and make $100,000?

To solve Barry’s question I simply amend the BEP formula to FC plus DP (desired profit)/(1-VC)

Or
($575,000+$100,000)/(1-VC)
Or
$675,000/.7
Or
$964,286

Here’s the Proof

Revenues                                    $964,286
Less: Variable costs @30%     $289,286

=Contribution to Fixed cost   $675,000
Less: Fixed cost                         $575,000

=Profit (loss)                             $100,000

If you’ve been able to follow so far you get the idea how easy to use yet powerful the BEP formula can be.  It can help Barry understand his expenses and how he might reduce them.  He could use it to set future sales and profit targets.  These targets could become the source for budgets which could help him to better manage his operations.

In summary, the basic BEP formula may be used with simple modifications for cash flow, after tax income, increases in fixed costs and lots, lots more.  You can use it to set sales targets, accept or reject business, analyze a change in cost structures, etc.

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About jaysanderscpa

Jay Sanders, CPA/PFS, CFP® "There's lots and lots of Numbers in business and your personal life but only some are relevant. The key is to know which one's matter, worry about them and forget the rest."
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