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What’s a break-even analysis?

A break-even analysis, in simple terms, is a financial calculation that helps you determine how much money you will need before your business idea becomes profitable.

You need to be able pay your daily production and operating costs and then make some extra.

It is important to determine your break-even point for businesses that need a lot more capital and upfront investment. This includes brick-and-mortar shops and businesses with lots of equipment.

To calculate the break-even point, you need to know two types of costs: fixed and variable.

Fixed cost An expense that is the same every month regardless of how many sales you make (e.g. real estate rent, insurance or business taxes)
Variable Cost: An expense that changes based on the number of sales you make (e.g. production costs such as raw materials, payroll for hourly employees, credit card processing fees, etc.)

The advantages of a break even analysis

A break-even analysis has many benefits. Here are some:

Smarter pricing. You might find that your prices aren’t high enough to cover your costs, regardless of all the factors involved. Profitability is the main driver.

Complete financial understanding. When there are so many things to think about, it’s easy for expenses to be overlooked. A break-even analysis can be a comprehensive look at your business and often uncovers hidden areas.

Specific sales goals. Businesses can determine how many sales they must make each day, week and month. This is a better way to go than aiming for a general goal to sell as many as possible. ).

Making better business decisions. However, if you do the math you might discover that it is not financially wise. You can make more sound financial decisions by performing a break-even analysis.

How do you calculate the break-even point

The break-even point analysis uses a simple formula: your fixed expenses divided by your average unit cost minus your variable charges.

This might seem confusing. Let’s get to the point.

You need to calculate how much profit you make from each unit that you sell. A unit could be, for example, a candle if it’s a candle manufacturer, a lawn-mowing service if your landscaping company is a landscaping company, or even a package of website hosting if you are a web developer.

Once you have a rough idea of your profit per unit, divide it by your fixed costs (basic costs that are the same each month)

Your contribution margin ratio is the amount of profit left over. This is the contribution margin ratio, because it adds sales dollars to fixed costs.

Shopify offers a free template for break-even analysis. A break-even calculator is also available from the US Small Business Administration (SBA).

Source

Collect data from your business

Keep track of every expense that you incur as a business.

Fixed Costs: Property Rent, Insurance, Software Subscriptions, Set Labor like your monthly retainer fee for your accountant or salary-based employee compensation, etc.
Variable Costs: Raw material, payment processing fees, and non-fixed labor such as hourly employees’ earnings and commissions, delivery costs, packaging costs, etc.
Average sales price: Find the average price for all of your products and services. If you don’t have any firm prices, you can make an educated guess. You can adjust it later if the numbers aren’t working.

Do not let one expense slip by the wayside. Variable costs such as a set of cocktail napkins branded for a special event or a promotional item you include with your ecommerce order might be included.

Enter the numbers

It’s now time to enter the numbers into the spreadsheet. It’s very handy, and we didn’t mean to exaggerate when we said so. Once you have added your numbers, the spreadsheet will calculate your total fixed cost and variable costs. The spreadsheet will calculate your final break-even point once you have added your average selling price.

Cell E3, or Break-Even Units, will be your final result. This is how many units you must sell to reach your break-even point.

This spreadsheet’s beauty is its flexibility. You can make as many adjustments and experiments as necessary to get the configuration that works for you.

Breakeven-analysis examples: Four use cases

There are many situations where it is worthwhile to perform a break-even analysis. Examples include:

1. Start a new business

A break-even analysis is necessary before you implement a business plan. This will help you decide if your idea is feasible. It will also force you to think about your revenue-generating strategy and be realistic about your costs.

2. Change your business model

A break-even analysis is necessary if you are considering changing your business model, such as switching from selling products to printing on demand. This will allow you to determine if your prices should change due to significant increases in startup costs.

3. Develop a new product

A break-even analysis should be done before you commit to a new product. This will allow you to calculate the variable costs associated with the new item as well as the price. You should calculate the break-even point, even if your fixed costs like utility bills are the same. This will give you an idea of how many units you’ll have to sell in order to achieve profitability.

4. Add a new channel of sales

Even if your prices are unchanged, adding a new channel to your sales can increase your costs. If you have been selling online but now want to open a shop in your local area, it is important to make sure that you are able to break even. This will help you avoid any financial hardship that could be detrimental to your business.

This applies to all new online sales channels, such as shoppable post on TikTokspan styling=”font-weight 400 ;”>. Your break-even analysis should include any extra costs for promotion (such as TikTok ads).

Tips to Lower Your Break-even Point

Is your break-even point impossible or unrealistic? You might be tempted to stop starting a business. You don’t have to abandon the idea of starting your own business. There are ways you can lower your break-even point.

1. Lower variable costs

It can be difficult to reduce variable expenses, especially in a new business. As you grow, however, it becomes easier for you to reduce these expenses. Talking to suppliers, switching suppliers or improving your production process are all ways to lower your costs. You may find that bubble wrap is more expensive than packing peanuts for delicate items.

2. Raise your prices

To breakeven, increase your prices. A higher profit margin will be earned for each unit sold. Consider what the market will tolerate and what customers expect when you consider a price increase. You will still need to sell enough, even though you may have fewer sales. Customers may expect better quality and customer service if you charge more.

3. Fixed costs lower

Consider the possibility of lowering your fixed costs. You will need to sell fewer units to break even if your fixed costs are lower. If opening a store is not financially feasible, you might consider selling online. These changes can dramatically lower your fixed costs, and consequently your break-even point.

Break even to get through

The break-even point analysis is a simple financial calculation that can make a big impact on your business’ long-term success.

This tool allows business leaders and owners to gain a better understanding of the company’s finances. This tool not only helps with the immediate goal to become profitable as quickly as possible but also guides business decisions throughout the company’s lifetime.

It’s never too late to perform a break-even analysis if you haven’t done one before. It takes only a few minutes (or more depending on how complex your business is) to analyze the numbers and determine where you stand and where you can go.

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Author: Amanda Gaid

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