Knowing What is PVU, your company’s pvu is will let you know that you have reached the point where your business is profitable on its own, which is every entrepreneur’s dream, right? It will also let you know what the balance between your expenses and your income is, so that you can take advantage of new investment opportunities.
When a company begins to make its way in the market, it is normal that certain obstacles and complications arise along the way. If these can be overcome, sooner or later the longed-for profitability is achieved, although there is a very important prior step: achieving a company’s break-even point.
According to Salesforce,
“The break-even point is established through a calculation that serves to define the moment in which a company’s income covers its fixed and variable expenses, that is, when you manage to sell the same as you spend, you neither win nor lose, you have reached the break-even point”.
Products or services really start to perform when this kind of phase is surpassed. Therefore, in the following article we will explain what it is and how to calculate the break-even point in a company.
grab your pencil, your books and your calculator!
Definition of PVU
The PVU, also known as unit selling price, is the price that represents the production costs of the good or service, per unit, plus the profit we have left after selling it. In other words, determining what PVU is can make or break your business.
The calculation of the PVU is crucial to reach the desired break-even point of the company. Once we are clear on what the PVU is, we will be able to determine our profitability.
Source: Pexels
Now that you understand perfectly what it is and why it is important to reach it, the second most important thing about this topic follows: how to reach that desired scenario. To achieve it, you need to follow these 7 steps on how to calculate the break-even point:
1. Determine the costs
First, you must define what type of expenses you will consider as business costs. When calculating the break-even point, any outlay related to the product or service is usually included among the costs. As a preview to an example of a company’s fixed cost that we will present later, consider the following as costs:
Merchandise, transportation, or storage of products, if your company is engaged in commerce.
The production of the product itself, if yours is a manufacturing company.
The provision of the service, if you are a service company. This would include the salaries of the workers and the supplies needed to provide the service.
Administration expenses, which include salaries of managers and administrators, rents, basic services, etc.
Selling expenses, which would include salesperson salaries and advertising expenses.
This does not usually include financial expenses, i.e., those related to acquired debts or taxes. However, if your business is small or just starting out, we recommend that you consider all expenses incurred by your company as costs.
2. Classify your fixed and variable costs
If you have already determined what outlays represent your company’s costs, the next step is to classify them into fixed costs (FC) and variable costs (VC). Let’s look at the differences between them:
Fixed costs
These are the ones that do not suffer an alteration due to activity levels, but generally remain the same, such as machinery and equipment maintenance, insurance, employees’ salaries, rents, among others.
As a small tip, it is good to know how to calculate the selling price of your products, so that all these fixed costs are more bearable.
Variable costs
As the name suggests, these are costs that vary, that increase or decrease according to a series of aspects:
The units you sell
The volume of production
The amount of services rendered, depending on your company’s line of business.
We are talking about costs that are given according to the activity levels of your business. Variable costs may include raw materials, fuel, spare parts, among others.
Having said this, it is time to apply some formulas. If you tend to be intimidated by numbers, don’t worry. They are quite simple, especially the selling price formula.
3. Find the Variable Unit Costs (CVU)
After having classified the Fixed Costs and Variable Costs, it is time to find the Unit Variable Cost. This is obtained after dividing the Total Variable Costs by the number of units produced (Q). This tells us what is the variable cost of each unit produced (Q).
Now, let’s put what we have read in this example of a company’s break-even point: If a company that sells caps has fixed costs of $500 and a variable cost per cap of $10, and produces 100 caps, the total costs are calculated as follows:
TC = CF + CV = CF + CVU*Q = 500 + 10*100 = $1,500.
4. Determine the Unit Selling Price (USP)
After knowing the unit variable cost of your product, you will need to determine the price it will have for customers. The unit selling price (USP) is the money value at which a good or service is estimated. All you have to do is apply the following selling price formula:
Selling price = (Total unit cost)/ (1 -% profit)
It is important to clarify that, although this sales price formula is available, there are external elements that can modify it. Among them are the competition, the market itself, or even the ‘bargaining’ that customers may make if it is something common in your industry.
Considering this, in general terms,the ideal is to set a 30% profit in relation to the cost that the product or service has for your company. However, do not rule out raising it to 40 or 45% according to the environment. To do so, you can use market research, which can be of great help in calculating the selling price.
5. Apply the break-even point formula
After obtaining the unit variable cost, you will proceed to apply the formula for calculating the break-even point, which is as follows:
Pe = CD / (PVU – CVU)
You must consider:
Pe: break-even point (when units sold generate revenues equal to costs)
CF: fixed costs.
PVU: unit selling price.
CVU: unit variable cost.
The result of this formula to calculate the break-even point is based on physical units of the product. If you want to focus on monetary units, you only have to multiply the result by the selling price.
6. Check the results
After applying the formula, it’s time to draw up a profit and loss statement to help you know how much you need to sell to cover your costs, or how many sales start generating profits.
Let’s look at an example. If you have a company that sells pants at a price of $40 per unit, and each pair of pants costs your company $24 plus sales commission expenses ($2), and your fixed expenses total $3,500, what would be your break-even point in sales units and monetary units?
This is solved like this. We have that:
CVU: 24 + 2 = 26
CF = 3500
Then, the formula applies:
Pe = CF / (PVU – CVU)
Pe = 3500 / (40 – 26)
Pe = 250 units.
Pe in monetary units: 250 x 40 = $10,000
Checking:
Sales (PVU x Q): 40 x 250 10000 10000
(-) CV (CVU x Q): 26 x 250 6500
(-) CF 3500
Net Profit 0
7. Interpret the results
Once you have solved the formula for a company’s break-even point, you must draw your conclusions about it.
Following the previous example, if your break-even point is reached with 250 pants sold, it means that from sale #251 you will be starting to generate profits, while the sale of 249 or less pants will represent losses for your venture.
Taking it to monetary units, we can say that $10,000 in pants sold represents your break-even point, that an amount lower than that represents losses, and that an amount higher than that represents profits for you.
Source: Pexels
Break-even profit
As stated by El Comercio, “by calculating the break-even point of a company, you make sure to decide the prices at which you should sell your products, so that you can establish proposals and business plans that will help you boost your profits”.
In other words, knowing what a company’s break-even point is goes far beyond measuring profitability, but will allow you to plan better actions for your business in the future. It also indicates a series of very important aspects to take into account to monitor its performance. For example:
how profitable is your current product line and how profitable is your previous one?
what is your margin of sales decline before you start generating losses?
how many units do you need to sell to make a profit?
how will a reduction in price or sales volume affect your profits?
how much increase in price or sales volume will you need to offset an increase in fixed costs?
On the other hand, reaching the break-even point allows you to know from what sales volume a company’s income equals its expenses. Among other advantages, we can mention the following:
Knowing how much you must sell to cover the company’s costs, that is, to reach the break-even point.
To be able to control these costs so that they do not break the break-even point reached.
Understand how much you need to sell to generate higher profits, which means exceeding the break-even point.
Plan and determine the profits you need, once you know the break-even point, so you know how much more you can aim for.
Define a basis for assigning reasonable prices to your products and services, which at the same time are the most favorable possible for the company.
It should be noted that these notions on how to calculate the break-even point are not only useful for a company, but also for other types of scenarios. For example, for the rent of an apartment, to put capital in a project, or in general, for all types of investments you plan to make.
As our professor explains:
“In this course you will see how to lay solid financial foundations to carry out your venture from scratch. In addition, tips and a methodology that will allow you to implement a profitable idea and not just sell for the sake of selling”.
what are you waiting for to sign up and calculate the break-even point in your financial plan?
Source: Pexels
Methods to calculate the break-even point
Being a bit more technical, we can find more variety in terms of methods to find the break-even point. But don’t worry, because they are still easy to understand formulas. For this, it may help to have the income and expenses table of a similar company and adapt it to yours.
First of all, let’s classify the methods.
1. Contribution margin
This equals a company’s revenue from sales, minus all costs that vary with respect to a cost factor related to production.
Pe= Fixed Cost / PVU – CVU
2. Algebraic or equation method
The income statement can also be expressed in equation form as follows:
TOTAL REVENUE = TOTAL COST (FIXED COST + VARIABLE COST)
3. Graphical method
With this method, the lines of total costs and total revenues are plotted to find their point of intersection, which is the same as the break-even point. This is the point at which total costs and total revenues are equal. For this point, remember to get yourself the aforementioned table of revenues and expenses of a company.
Consider for this chart from The Salmon Blog:
TI = Total revenue
TC = Total Cost
P = Loss
CF = Fixed Cost
CV = Variable Cost
You already know what a company’s break-even point is. After all that has been said, you will better understand how this concept can help you test its viability. If your business has constant revenues, the time at which break-even points are reached will remain predictable for the better.
On the other hand, if your business activity becomes volatile, the break-even point will become unstable. Such a scenario can complicate your company’s finances or the payments it normally makes to be able to produce. If this is your scenario, we recommend that you apply the PHVA cycle to achieve continuous improvement of your teams and projects.
Most importantly, the break-even point will help you to be more certain of the profit level of your business. Always monitor this aspect of your business and you will know when to invest to produce more, how you can vary your prices and offers, or how to manage the financial aspect more accurately.