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Computing the break-even point (the number of sales needed for revenues received to equal total costs) helps determine when a product or product line will become profitable. After a product reaches break-even, sales start to contribute to profits.

To calculate the break-even point, first you need to figure out the cost of goods (for example, your wholesale price or cost of manufacturing) or average variable costs (costs such as materials, shipping, or commission that vary with the number of units sold) and your fixed costs (charges such as rent or insurance that are the same each month regardless of how much business you do). Then plug the amounts into these two formulas:

 revenues – cost of goods (variable) = gross margin

 fixed costs ÷ gross margin = break-even point (in unit sales)

Figure 2-5 shows this relationship. This graph of the break-even point shows fixed costs (the dashed horizontal line) to variable costs (the solid diagonal line) to plot total costs. After revenues surpass the break-even point, each sale contributes to profits (the shaded area on the right).

FIGURE 2-5: The break-even chart plots fixed plus variable costs; each sale after the break-even point contributes to profits.

The break-even analysis tool from the Harvard Business School Toolkit (http://hbswk.hbs.edu/archive/1262.html) can also help you calculate your break-even point.