Break-Even Analysis: A Guide for Entrepreneurs
When starting a business, one of the most important things to understand is the break-even point.
This is the point at which your company makes enough money to cover its costs. Past this point, the company starts to make a profit.
Finding the break-even point through the analysis of costs is one of the most useful processes an entrepreneur can undertake. It helps you answer questions such as:
What volume of sales do I need to break even?
What profit can I expect from a particular volume of sales?
What price should this product be sold at?
Should advertising be increased or decreased?
Carrying out a break-even analysis can help you understand the financial viability of your business and make informed decisions. Here's how to do it:
Separate your variable costs from your overhead
Make a tally of all your costs separated by type – either fixed or variable. If you come across a mixed cost, like a bill with a flexible usage fee and a flat subscription cost, work out which is the greater part and add it to the appropriate list. You want to finish knowing two things: your total fixed costs and the average variable cost of providing one product or service (known as the variable cost per unit). If you take away the variable cost per unit from your sales price, you have your contribution (or profit) margin.
Now carry out the following calculation to find your break-even point
TOTAL FIXED COSTS ÷ CONTRIBUTION MARGIN = SALES VOLUME REQUIRED TO BREAK EVEN
Example: A window cleaner has fixed costs of $15,000, while the business’s variable costs average $15 per job and the charge-out rate is $40 per job, so his contribution margin is $25. To break even he needs to carry out: $15,000 ÷ $25 ($40 – $15) = 600 jobs
For a more honest estimate of viability, the business owner factors their own salary into the fixed costs part of the equation.
Dollars
To obtain a dollar break-even point, you need to express the contribution margin as a decimal figure converted from a percentage. For example:
$25 = 62.5% of $40
62.5% = 0.625
Now simply divide the fixed costs by the contribution margin (decimal figure). So, our window cleaner’s annual sales target to cover costs would therefore be:
$15,000 ÷ 0.625 = $24,000
Hours
If your business is a service provider that charges an hourly rate, you’ll want to know your hours-worked break-even point. Simply divide your fixed costs by your hourly call-out rate. Say, for example, our window cleaner decided to charge $40 by the hour, after finding out a minority of jobs were taking up a lot of his time. His hours’ target to reach break-even would be:
$15,000 ÷ $40 = 375 HOURS
Again, in both cases, he’d be wise to factor his salary expectations into his costs for a truer figure.
The break-even point is an essential concept for any entrepreneur to understand. By analyzing your costs and revenue, you can make informed decisions about pricing, advertising, and other aspects of your business.
By understanding your break-even point, you can ensure the financial viability of your business and set realistic goals for growth and profitability.
