Do you know how much money you need to make just to cover the costs of doing business, and avoid loosing money? In other words – have you done a breakeven analysis to calculate your breakeven point? If not, it’s time that you did!
Without this crucial piece of the business puzzle, you could be making some less than ideal decisions.
What does break-even mean?
You don’t need to be an accountant to know the relevance of the break-even point. For a small business or any other enterprise, it is essential to cover all the costs before realising profits.
At the onset of operations, you should have calculated all costs, fixed and variable. But it does not stop there. That’s covered your operating costs, and resulted in a nil profit/loss situation, but a nil profit is a sure way to go broke.
Let’s see why…
We need to also consider costs like debt repayments, and future investment such as purchasing the plant and equipment (CAPEX) that you might need for the next 5 or so years. It is also safe to say to say that you need to live on. There’s probably personal mortgages or rent to pay, and whatever you need to live on. Add all that on top of day to day business costs, and you have the amount of AFTER tax profit that you need as a minimum.
But, for the sake of simplicity let’s just say that if you’re not achieving breakeven with at least enough additional profit to pay for tax, future investment, and your cost of living – you’re probably going to really need to turn the business around.
What smart small business owners do?
As a small business owner, you don’t leave anything to chance. A smart entrepreneur who is determined to succeed will never miss a beat. It would be very helpful to calculate breakeven point, gross profit and net profit.
If consistently done, you can easily make adjustments to come up with the actual number of goods you need to sell and the corresponding price target per product.
How to calculate the break-even point
Calculating the break-even point is not as complex as you would imagine. The key is to have the applicable data so you can perform a meaningful breakeven point analysis.
What is the formula for computing breakeven point? The major components that should be factored in are the fixed and variable costs, plus your selling price.
Your objective is to find out exactly the number of products you must sell to hit the breakeven point. The formula is simple and straight-forward.
Breakeven Point (per Unit) = Fixed costs / (Selling Price – Variable Costs)
Example of determining the breakeven point
For illustration purposes, let us imagine you’re in the business of selling leather wallets. Your profit objective is to earn $200 for every wallet sold and following are the assumptions:
- Fixed Cost (FC) = $250,000
Your fixed costs include the regular expenses such as operating expense and labor cost which is not a function of the sales volume.
- Variable Cost (VC) per wallet = $150
Since leather wallets are your main product, you need to purchase leather to produce the wallet. If the cost to produce one wallet is $150, then your variable cost refers to the cost of goods sold.
- Selling Price (SP) per wallet = $350
The selling price per leather wallet comes out to $350 since your intended profit margin as mentioned earlier is $200 per piece or unit.
Bear in mind that you have limited control over the fixed and variable costs, so your pricing strategy makes a big difference to your break even point.
Now, let’s work out the breakeven point for this wallet business using the formula for calculating breakeven point.
Breakeven Point (per wallet) = Fixed costs/SP – VC (both per wallet) = $250,000/$350-$150
1,250 wallets = $250,000/$200
So, if you can sell 1,250 wallets you’ve hit your breakeven point which will cover both your fixed costs and your variable costs.
To double-check and validate, multiply the required breakeven volume by your price per wallet:
1,250 X $350 = $437, 500 (gross profit)
Next, multiply the variable cost per wallet by the total number of required wallets then add the fixed cost. The sum should equal the gross profit.
($150 X 1,250) + $250,000 = $437,500 (Gross profit)
$187,500 + $250,000 = $437,500
$437,500 = $437,500
In summary, if you sell more than 1250 wallets you’re breakingeven – that’s a great start!!! We suggest that you speak with your accountant or financial advisor to figure out what you need to also factor in taxes, future expenses and your cost of living etc.
Knowing your breakeven point is essential for running and monitoring every business, and for guiding decision making – regardless of size. The best way to do this is to conduct a breakeven point analysis following the formula above. We’ve used a basic example to demonstrate the formula, but hopefully you can go put it to work in your business now.
It will level up your financial intelligence and put you on the right path to business success.
When was the last time you calculated your breakeven point?