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Making a Risk Management Plan for Your Business
It’s impossible to eliminate all business risk. Therefore, it’s essential for having a plan for its management. You’ll be developing one covering compliance, environmental, financial, operational and reputation risk management. These guidelines are for making a risk management plan for your business.
Developing Your Executive Summary
When you start the risk management plan with an executive summary, you’re breaking apart what it will be compromised of into easy to understand chunks. Even though this summary is the project’s high-level overview, the goal is describing the risk management plan’s approach and scope. In doing so, you’re informing all stakeholders regarding what to expect when they’re reviewing these plans so that they can set their expectations appropriately.
Who Are the Stakeholders and What Potential Problems Need Identifying?
During this phase of making the risk management plan, you’re going to need to have a team meeting. Every member of the team must be vocal regarding what they believe could be potential problems or risks. Stakeholders should also be involved in this meeting as well to help you collect ideas regarding what could become a potential risk. All who are participating should look at past projects, what went wrong, what is going wrong in current projects and what everyone hopes to achieve from what they learned from these experiences. During this session, you’ll be creating a sample risk management plan that begins to outline risk management standards and risk management strategies.
Evaluate the Potential Risks Identified
A myriad of internal and external sources can pose as risks including commercial, management and technical, for example. When you’re identifying what these potential risks are and have your list complete, the next step is organizing it according to importance and likelihood. Categorize each risk according to how it could impact your project. For example, does the risk threaten to throw off timelines or budgets? Using a risk breakdown structure is an effective way to help ensure all potential risks are effectively categorized and considered. Use of this risk management plan template keeps everything organized and paints a clear picture of everything you’re identifying.
Assign Ownership and Create Responses
It’s essential to ensure a team member is overseeing each potential risk. That way, they can jump into action should an issue occur. Those who are assigned a risk, as well as the project manager, should work as a team to develop responses before problems arise. That way, if there are issues, the person overseeing the risk can refer to the response that was predetermined.
Have a System for Monitoring
Having effective risk management companies plans includes having a system for monitoring. It’s not wise to develop a security risk management or compliance risk management plan, for example, without having a system for monitoring. What this means is there’s a system for monitoring in place to ensure risk doesn’t occur until the project is finished. In doing so, you’re ensuring no new risks will potentially surface. If one does, like during the IT risk management process, for example, your team will know how to react.
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Break Even Point: Formula, Definition, Analysis and Guide
- by Casandra Campbell
- Sep 29, 2022
- 12 minute read
If you’re a business owner, or thinking about becoming one, you should know how to do a break-even analysis. It’s a crucial activity for making important business decisions and financial planning .
A break-even analysis will tell you exactly what you need to do in order to make back your initial investment and begin turning a profit.
Table of Contents
What is break-even analysis?
Benefits of a break-even analysis, how to calculate break-even point, break-even analysis examples: when to use it, break-even analysis limitations, tips to lower your break-even point, download your free break-even analysis template, break-even analysis faq.
Break-even analysis is a small-business accounting process for determining at what point a company, or a new product or service, will be profitable. It’s a financial calculation used to determine the number of products or services you must sell to at least cover your production costs.
The break-even theory is based on the fact that there is a minimum product level at which a venture neither makes profit nor loss. M.B. Ndaliman, An Economic Model for Break-even Analysis
For example, a break-even analysis could help you determine how many cellphone cases you need to sell to cover your warehousing costs, or how many hours of service you’ll have to bill to pay for your office space. Anything you sell beyond your break-even point will add profit.
To fully understand break-even analysis for your business, you should be aware of your fixed and variable costs.
- Fixed costs: expenses that stay the same no matter how much you sell.
- Variable costs: expenses that fluctuate up and down with production or sales volume.
Learn more: Small Business Accounting 101: How To Set Up and Manage Your Books
Many small and medium-sized businesses never perform any meaningful financial analysis. They don’t know how many units they have to sell to see a return on their capital.
Break-even analysis is a way to find out the minimum sales volume so that a business does not suffer losses. Lis Sintha, Importance of Break-Even
A break-even point analysis is a powerful tool for planning and decision making, and for highlighting critical information like costs, quantities sold, prices, and so much more.
Finding your break-even point will help you understand how to price your products better. A lot of psychology goes into effective pricing, but knowing how it will affect your gross profit margins is just as important. You need to make sure you can pay your bills.
Cover fixed costs
When most people think about pricing, they think about variable cost—that is, how much their product costs to make. But in addition to variable costs, you also need to cover your fixed costs, like insurance or web development fees. Performing a break-even analysis helps you do that.
Catch missing expenses
It’s easy to forget about expenses when you’re thinking through a small business idea. When you do a break-even analysis you have to lay out all your financial commitments to figure out your break-even point. This will limit the number of surprises down the road.
Set sales revenue targets
After completing a break-even analysis, you know exactly how many sales you need to make to be profitable. This will help you set more concrete sales goals for you and your team. When you have a clear number in mind, it will be much easier to follow through.
Make smarter decisions
Entrepreneurs often make business decisions based on emotion. If they feel good about a new venture, they go for it. How you feel is important, but it’s not enough. Successful entrepreneurs make their decisions based on facts. It will be a lot easier to make decisions when you’ve put in the work and have useful data in front of you.
Limit financial strain
Doing a break-even analysis helps mitigate risk by showing you when to avoid a business idea. It will help you avoid failures and limit the financial toll that bad decisions can have on your business. Instead, you can be realistic about the potential outcomes.
Fund your business
A break-even analysis is a key component of any business plan . It’s usually a requirement if you want to take on investors or borrow money to fund your business. You have to prove your plan is viable. More than that, if the analysis looks good, you will be more comfortable taking on the burden of financing.
Your break-even point is equal to your fixed costs, divided by your average selling price, minus variable costs. It is the point at which revenue is equal to costs and anything beyond that makes the business profitable.
Formula: break-even point = fixed cost / (average selling price - variable costs)
Before we calculate the break-even point, let’s discuss how the break-even analysis formula works. Understanding the framework of the following formula will help determine profitability and future earnings potential.
Basically, you need to figure out what your net profit per unit sold is and divide your fixed costs by that number. This will tell you how many units you need to sell before you start earning a profit.
As you now know, your product sales need to pay for more than just the costs of producing them. The remaining profit is known as the contribution margin ratio because it contributes sales dollars to the fixed costs.
Now that you know what it is, how it works, and why it matters, let's break down how to calculate your break-even point.
Before we get started, get your free copy of the break-even analysis template . After you make a copy, you’ll be able to edit the template and do your own calculations.
Step 1: Gather your data
The first step is to list all the costs of doing business—everything including the cost of your product, rent, and bank fees. Think through everything you have to pay for and write it down.
The next step is to divide your costs into fixed costs and variable costs.
Fixed costs are any costs that stay the same, regardless of how much product you sell. This could include things like rent, software subscriptions, insurance, and labor.
Make a list of everything you have to pay for, no matter what. In most cases, you can list total expenses as monthly amounts, unless you’re considering an event with a shorter timeframe, such as a three-day festival. Add everything up. If you’re using the break-even analysis spreadsheet, it will do the math for you automatically.
Variable costs are costs that fluctuate based on the amount of product you sell. This could include things like materials, commissions, payment processing, and labor.
Some costs can go in either category, depending on your business. If you have salaried staff, they will go under fixed costs. But if you pay part-time hourly employees who only work when it's busy, they will be considered variable costs.
Make a list of all your costs that fluctuate depending on how much you sell. List the price per unit sold and add up all the costs.
Finally, decide on a price. Don’t worry if you’re not ready to commit to a final price yet. You can change this later. Keep in mind, this is the average price. If you offer some customers bulk discounts, it will lower the average price.
Step 2: Plug in your data
Now it’s time to plug in your data. The spreadsheet will pull your fixed cost total and variable cost total up into the break-even calculation. All you need to do is to fill in your average price in the appropriate cell. After that, the math will happen automatically. The number that gets calculated in the top right cell under Break-Even Units is the number of units you need to sell to break even.
In the break-even analysis example above, the break-even point is 92.5 units.
Step 3: Make adjustments
Feel free to experiment with different numbers. See what happens if you lower your fixed or variable costs or try changing the price. You may not get it right the first time, so make adjustments as you go.
Warning: Don’t forget any expenses
The most common pitfall of break-even-point analysis is forgetting things—especially variable costs. Break-even analyses are an important step toward making important business decisions. That’s why you need to make sure your data is as accurate as possible.
To make sure you don’t miss any costs, think through your entire operations from start to finish. If you think through your ecommerce packaging experience, you might remember that you need to order branded tissue paper, and that one order lasts you 200 shipments.
If you’re thinking through your event setup, you might remember that you’ll need to provide napkins along with the food you’re selling. These are variable costs that need to be included.
If you need further help, use a break-even calculator to help you determine your financial analysis.
There are four common scenarios for when it helps to do a break-even analysis.
1. Starting a new business
If you’re thinking about starting a new business , a break-even analysis is a must. Not only will it help you decide if your business idea is viable, it will force you to do research and be realistic about costs, and make you think through your pricing strategy.
2. Creating a new product
If you already have a business, you should still do a break-even analysis before committing to a new product —especially if that product is going to add significant expense. Even if your fixed costs, like an office lease, stay the same, you’ll need to work out the variable costs related to your new product and set prices before you start selling.
3. Adding a new sales channel
Any time you add a new sales channel, your costs will change—even if your prices don’t. For example, if you’ve been selling online and you’re thinking about doing a pop-up shop , you’ll want to make sure you at least break even. Otherwise, the financial strain could put the rest of your business at risk.
This applies equally to adding new online sales channels , like shoppable posts on Instagram . Will you be planning any additional costs to promote the channel, like Instagram ads? Those costs need to be part of your break-even analysis.
4. Changing your business model
If you’re thinking about changing your business model, for example, switching from dropshipping products to carrying inventory, you should do a break-even analysis. Your startup costs could change significantly, and this will help you figure out if your prices need to change too.
Learn more: 7 Ways Small Businesses Can Save Money In Their First Year
Break-even analysis plays an important role in bookkeeping and making business decisions, but it’s limited in the type of information it can provide.
Not a predictor of demand
It’s important to note that a break-even analysis is not a predictor of demand. It won’t tell you what your sales are going to be, or how many people will want what you’re selling. It will only tell you the amount of sales you need to make to operate profitably.
Dependent on reliable data
Sometimes costs fall into both fixed and variable categories. This can make calculations complicated and you’ll likely need to wedge them into one or the other. For example, you may have a baseline labor cost no matter what, as well as an additional labor cost that could fluctuate based on how much product you sell.
The accuracy of your break-even point depends on accurate data. If you don’t feed good data into a break-even formula, you won’t get a reliable result.
Many businesses have multiple products with multiple prices. Unfortunately, the break-even point formula doesn’t reflect this kind of nuance. You’ll likely need to work with one product at a time, or estimate an average price based on all the products you might sell. If this is the case, it’s best to run a few different scenarios to be better prepared.
As prices fluctuate, so do costs. This model assumes that only one thing changes at a time. Instead, if you lower your price and sell more, your variable costs might decrease because you have more buying power or are able to work more efficiently. Ultimately, it’s only an estimate.
The break-even analysis ignores fluctuations over time. Your timeframe will be dependent on the period you use to calculate fixed costs (monthly is most common). Although you’ll see how many units you need to sell over the course of the month, you won’t see how things change if your sales fluctuate week to week, or seasonally over the course of a year. For this, you’ll need to rely on good cash flow management and possibly a solid sales forecast .
In addition, break-even analysis doesn’t take the future into account. If your raw material costs double next year, your break-even point will be a lot higher, unless you raise your prices. If you raise your prices, you could lose customers. This delicate balance is always in flux.
As a new entrant to the market, you’re going to affect competitors and vice versa. They could change their prices, which could affect demand for your product, causing you to change your prices too. If they grow quickly and a raw material you both use becomes more scarce, the cost could go up.
Ultimately, a break-even analysis will give you a very solid understanding of the baseline conditions for being successful. It is a must. But it’s not the only research you need to do before starting or making changes to a business.
What if you complete your break-even analysis and find out that the number of units you need to sell seems unrealistic or unattainable? Don’t panic: you may be able to make some adjustments to lower your break-even point.
1. Lower fixed costs
See if there’s an opportunity to lower your fixed costs. The lower you can get them, the fewer units you’ll need to sell in order to break even. For example, if you’re thinking about opening a retail store and numbers aren’t working out, consider selling online instead. How does that affect your fixed costs?
2. Raise your prices
If you raise your prices, you won’t need to sell as many units to break even. The marginal contribution per unit sold will be higher. When thinking about raising your prices, be mindful of what the market is willing to pay and of the expectations that come with a price. You won’t need to sell as many units, but you’ll still need to sell enough—and if you charge more, buyers may expect a better product or better customer service.
3. Lower variable costs
Lowering your variable costs is often the most difficult option, especially if you’re just going into business. But the more you scale, the easier it will be to reduce variable costs. It’s worth trying to lower your costs by negotiating with your suppliers, changing suppliers, or changing your process. For example, maybe you’ll find that packing peanuts are cheaper than bubble wrap for shipping fragile products .
Don’t forget to grab your free break-even analysis template . You can also save it as a Microsoft Excel sheet. To save your own editable version of the spreadsheet, click File → Make a copy.
Doing a break-even analysis is essential for making smart business decisions. The next time you’re thinking about starting a new business, or making changes to your existing business, do a break-even analysis so you’ll be better prepared.
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What is a break-even point (bep), what are the three methods to calculate your break-even point.
- Fixed costs: Expenses your business has to pay regardless of how many units you make or sell.
- Variable costs: Expenses that increase or decrease depending on your level of production or sales volume.
- Average sales price: The amount you will charge customers per unit of your product, averaged to include any bulk discounts you may offer.
What’s a good margin of safety?
What’s the difference between break-even analysis and break-even point.
Break-even point refers to a measure of the margin of safety. A break-even analysis tells you how many sales you must make to cover the total costs of production.
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5 Easy Steps to Creating a Break-Even Analysis
- What Break-Even is Used For
Gathering Information for Analysis
- Steps to Break-Even Analysis
Analyzing a Break-Even Chart
Break-even is one of those vital numbers that can mean success or failure to a small business. If you are breaking even your income is are equal to your costs. You have no profit or loss at this point. But, above the break-even point, every dollar of sales is pure profit.
How to Use a Break-Even Analysis in Financial Planning
A break-even analysis is important in several different situations:
- As your business plans new products, knowing the break-even point helps you price more efficiently.
- As you plan your overall business cash and profit strategy, break-even can be used to determine profit points for product lines.
- As your business plans for financing, knowing your overall company breakeven point can help make your case for a business loan.
A lender or investor will probably want to see this information in the financial report section of your business plan .
Before you begin your break-even analysis, you'll need some information. Let's say you're dong an analysis for a potential new product. Make a list of all your costs and expenses relating to that product, including facilities, the cost of materials and supplies, machines or equipment, and costs for paying employees to make the product and prepare it to ship.
You'll also need to know two other pieces of information:
- The range of prices you are considering, starting at $0.00
- The range of quantities you estimate being able to sell, starting at none (0)
You will need to separate out fixed costs and variable costs . Fixed costs are those you must pay even if you have no sales (like rent and utilities). Variable costs are those you spend to make and sell and ship products (like raw materials, supplies, and labor).
5 Steps to Creating a Break-Even Analysis
Here are the steps to take to determine break-even:
- Determine variable unit costs: Determine the variable costs of producing one unit of this product. Variable costs are those costs associated with making the product or buying it wholesale. If you are making a product, you will need to know the cost of all the components that go into that product. For example, if you are printing books, your variable unit costs are paper, binding, and glue for one book, and the cost to put one book together.
- Determine fixed costs: Fixed costs are costs to keep your business operating, even if you didn't produce any products. To determine fixed costs, add up the cost of running your factory for one month. These costs would include rent or mortgage, utilities, insurance, salaries of non-production employees, and all other costs. Don't forget the cost to design the product and packaging, make the prototype, and maybe patent your product.
- Determine unit selling price: Determine the unit selling price for your product. This price may change as you see where your break-even point is.
- Determine sales volume and unit price: The break-even point will change as the sales volume for this product and the unit price change.
- Create a spreadsheet: To do a break-even calculation, you will construct or use a spreadsheet then turn the spreadsheet into a graph. The spreadsheet will plot break-even for each level of sales and product price, and it will create a graph showing you break-even for each of these prices and sales volumes.
A simple formula for break-even is:
Break-even quantity = Fixed costs/(Sales price per unit –Variable cost per unit).
This formula is best expressed in a spreadsheet because variable cost changes. The spreadsheet shows you break-even for a range of costs and sales prices.
You can use Excel or another spreadsheet to create a break-even analysis chart. SCORE has an Excel template , or you can use this one form Microsoft . You'll need someone who's familiar with Excel to tweak the spreadsheet to your specific situation.
Now that you have break-even, what do you do with this information? You want to find the highest price you can sell the product at and still make a profit. See what happens when you change either fixed or variable costs to see what happens if you reduce them. Maybe you can increase the volume by finding new markets. What happens when output volume rises or falls. All of these can affect your business profits on this product.
Of course, a break-even analysis isn't created in a vacuum. If you're creating a new product that no one's ever seen before, you have no idea what the volume would be or how soon competitors might pop up. But at least it gives you a way to begin your search for the "best" price for your product.
SCORE.org. " Break-Even Analysis Template ." Accessed Sept. 10, 2020.
Corporate Finance Institute. " Break Even Analysis ." Accessed Sept. 10, 2020.
Harvard Business Review. " A Quick Guide to Breakeven Analysis ." Accessed Sept. 10, 2020.
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Breakeven Point (BEP)
Breakeven point definition.
The breakeven point is the volume of sales required for the company to reach profitability.
The breakeven point can be expressed in volume, in value, or in days of revenues .
Breakeven point formula
There are 3 factors in the breakeven calculation:
- the sale price
- the level of variable costs
- the level of fixed costs
The breakeven point is reached when the margin on variable costs generated by the company equals the total amount of its fixed costs.
We have the following relationships:
Unitary margin on variable costs = Sale price - Unitary variable costs
Breakeven point in volume = Total fixed costs / Unitary margin on variable costs
Breakeven point in value = Breakeven point in volume x Sale price
Breakeven point in days of sales = Breakeven point in value / (Forecasted revenues / 365)
Example of breakeven analysis
Let's take the example of a shop. The shop sells its products at an average of £100/unit, has a rent of £660/month for sole fixed cost, and buys the products its sells at £40/unit.
Unitary margin on variable costs = 100 (sale price) - 40 (unitary variable costs) = £60
Breakeven point in volume = 660 (total fixed costs = rent) / 60 (unitary margin on variable costs) = 11 sales a month
Breakeven point in value = 11 (nb. of sales to break even) x 100 (sale price) = £1,100
Graphical representation of the breakeven point
The breakeven analysis can also be represented on a chart. The image below show the breakeven computation of the previous example on an annual basis:
As you can see, the company will break even after 132 sales, i.e. when the total margin on variable costs equals the annual amount of the rent of £660/month x 12 months = £7,920.
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Break-Even Point Formula and Analysis: How to Calculate BEP for Your Business
- Growth Strategies
When will I break even? It’s one of the biggest questions you need to answer when you’re starting a business. And that’s why it’s so crucial to conduct a break-even analysis, which helps you determine fixed costs (like rent) and variable costs (like materials) so you can set your prices appropriately and forecast when your business will become profitable .
Central to the break-even analysis is the concept of the break-even point (BEP).
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What is the break-even point for a business?
A business’s break-even point is the stage at which revenues equal costs. Once you determine that number, you should take a hard look at all your costs — from rent to labor to materials — as well as your pricing structure.
Then ask yourself these questions: Are your prices too low or your costs too high to reach your break-even point in a reasonable amount of time? Is your business sustainable?
How to calculate your break-even point
There are a few basic break-even point formulas to help you calculate break-even point for your business. One is based on the number of units of product sold and the other is based on points in sales dollars. Here is how to caclulate break-even point:
How to calculate a break-even point based on units: Divide fixed costs by the revenue per unit minus the variable cost per unit. The fixed costs are those that do not change no matter how many units are sold. The revenue is the price for which you’re selling the product minus the variable costs, like labor and materials.
Break-Even Point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)
When determining a break-even point based on sales dollars: Divide the fixed costs by the contribution margin. The contribution margin is determined by subtracting the variable costs from the price of a product. This amount is then used to cover the fixed costs.
Break-Even Point (sales dollars) = Fixed Costs ÷ Contribution Margin
Contribution Margin = Price of Product – Variable Costs
To get a better sense of what this all means, let’s take a more detailed look at the formula components.
- Fixed costs: As noted above, fixed costs are not affected by the number of items sold, such as rent paid for storefronts or production facilities, computers, and software. Fixed costs also include fees paid for services like graphic design, advertising, and public relations.
- Contribution margin: The contribution margin is calculated by subtracting an item’s variable costs from the selling price. So if you’re selling a product for $100 and the cost of materials and labor is $40, then the contribution margin is $60. This $60 is then used to cover the fixed costs, and if there is any money left after that, it’s your net profit.
- Contribution margin ratio: This figure, usually expressed as a percentage, is calculated by subtracting your fixed costs from your contribution margin. From there, you can determine what you need to do to break even, like cutting production costs or raising your prices .
- Profit earned following your break even: Once your sales equal your fixed and variable costs, you have reached the break-even point, and the company will report a net profit or loss of $0. Any sales beyond that point contribute to your net profit.
How to use a break-even analysis
A break-even analysis allows you to determine your break-even point. But this isn’t the end of your calculations. Once you crunch the numbers, you might find that you have to sell a lot more products than you realized to break even.
At this point, you need to ask yourself whether your current plan is realistic, or whether you need to raise prices, find a way to cut costs, or both. You should also consider whether your products will be successful in the market. Just because the break-even analysis determines the number of products you need to sell, there’s no guarantee that they will sell.
Ideally, you should conduct this financial analysis before you start a business so you have a good idea of the risk involved. In other words, you should figure out if the business is worth it. Existing businesses should conduct this analysis before launching a new product or service to determine whether or not the potential profit is worth the startup costs .
Break-even analysis examples
A break-even analysis isn’t just useful for startup planning. Here are some ways that businesses can use it in their daily operations and planning.
- Prices: If your analysis shows that your current price is too low to enable you to break even in your desired timeframe, then you might want to raise the item’s cost. Make sure to check the cost of comparable items, though, so you’re not price setting yourself out of the market.
- Materials: Are the cost of materials and labor unsustainable? Research how you can maintain your desired level of quality while lowering your costs.
- New products: Before you launch a new product, take into account both the new variable costs as well as the fixed ones, like design and promotion fees.
- Planning: When you know exactly how much you need to make, it’s easier to set longer-term goals. For example, if you want to expand your business and move into a larger space with higher rent, you can determine how much more you need to sell to cover new fixed costs.
- Goals: If you know how many units you need to sell or how much money you need to make to break even, it can serve as a powerful motivational tool for you and your team.
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What Is a Break-Even Analysis?
The break-even analysis lets you determine what you need to sell, monthly or annually, to cover your costs of doing business—your break-even point.
Understanding break-even analysis
The break-even analysis is not our favorite analysis because:
- It is frequently mistaken for the payback period, the time it takes to recover an investment. There are variations on break even that make some people think we have it wrong. The one we do use is the most common, the most universally accepted, but not the only one possible.
- It depends on the concept of fixed costs, a hard idea to swallow. Technically, a break-even analysis defines fixed costs as those costs that would continue even if you went broke. Instead, you may want to use your regular running fixed costs, including payroll and normal expenses. This will give you a better insight on financial realities. We call that “burn rate” these post-Internet days.
- It depends on averaging your per-unit variable cost and per-unit revenue over the whole business.
Over the past few years, the break-even analysis has fallen out of favor with financial analysts. It is okay when done right, can be useful, but not for all businesses and not for all situations. And, to add to the confusion, the term “break-even” is often used to refer to “payback” or “payback period.” And there are several ways to do the analysis. But what is shown here is the most common.
Three assumptions of the break-even analysis
The break-even analysis depends on three key assumptions:
1. Average per-unit sales price (per-unit revenue):
This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get this number from your sales forecast.
For non-unit based businesses, make the per-unit revenue one dollar and enter your costs as a percent of a dollar. The most common questions about this input relate to averaging many different products into a single estimate.
The analysis requires a single number, and if you build your sales forecast first, then you will have this number. You are not alone in this, the vast majority of businesses sell more than one item, and have to average for their break-even analysis.
2. Average per-unit cost:
This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per dollar of revenue or unit of service delivered, to deliver that service.
If you are using a units-based sales forecast table (for manufacturing and mixed business types), you can project unit costs from the sales forecast table. If you are using the basic sales forecast table for retail, service and distribution businesses, use a percentage estimate, e.g., a retail store running a 50 percent margin would have a per-unit cost of .5, and a per-unit revenue of 1.
3. Monthly fixed costs:
Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke. Instead, we recommend that you use your regular running fixed costs, including payroll and normal expenses (total monthly operating expenses). This will give you a better insight on financial realities.
If averaging and estimating is difficult, use your profit and loss table to calculate a working fixed cost estimate—it will be a rough estimate, but it will provide a useful input for a conservative break-even analysis. As sales increase, the profit line passes through the zero or break-even line at the break-even point. This is a classic business chart that helps you consider your bottom-line financial realities. Can you sell enough to make your break-even volume?
The break-even analysis depends on assumptions made for average per-unit revenue, average per-unit cost, and fixed costs. These are rarely exact. We recommend that you do the break-even table twice; first, with educated guesses for assumptions, as part of the initial assessment, and later on, using your detailed sales forecast and profit and loss numbers. Both are valid uses.
Do you have any questions about running a break-even analysis?
Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry .
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What Is Break-Even Analysis and How to Calculate It for Your Business?
You may have an idea that spurs you to open a business or launch a new product on little more than a hope and a dream. Or, you might just be thinking about expanding a product offering or hiring additional personnel. It’s wise, however, to limit your risk before jumping in. A break-even analysis will reveal the point at which your endeavor will become profitable—so you can know where you’re headed before you invest your money and time.
A break-even analysis will provide fodder for considerations such as price and cost adjustments. It can tell you whether you may need to borrow money to keep your business afloat until you’re pocketing profits, or whether the endeavor is worth pursuing at all.
What Is Break-Even Analysis?
A break-even analysis is a financial calculation that weighs the costs of a new business, service or product against the unit sell price to determine the point at which you will break even. In other words, it reveals the point at which you will have sold enough units to cover all of your costs. At that point, you will have neither lost money nor made a profit.
- A break-even analysis reveals when your investment is returned dollar for dollar, no more and no less, so that you have neither gained nor lost money on the venture.
- A break-even analysis is a financial calculation used to determine a company’s break-even point (BEP). In general, lower fixed costs lead to a lower break-even point.
- A business will want to use a break-even analysis anytime it considers adding costs—remember that a break-even analysis does not consider market demand.
- There are two basic ways to lower your break-even point: lower costs and raise prices.
How Break-Even Analysis Works
A break-even analysis is a financial calculation used to determine a company’s break-even point (BEP). It is an internal management tool, not a computation, that is normally shared with outsiders such as investors or regulators. However, financial institutions may ask for it as part of your financial projections on a bank loan application.
The formula takes into account both fixed and variable costs relative to unit price and profit. Fixed costs are those that remain the same no matter how much product or service is sold. Examples of fixed costs include facility rent or mortgage, equipment costs, salaries, interest paid on capital, property taxes and insurance premiums.
Variable costs rise and fall according to changes in sales. Examples of variable costs include direct hourly labor payroll costs, sales commissions and costs for raw material, utilities and shipping. Variable costs are the sum of the labor and material costs it takes to produce one unit of your product.
Total variable cost is calculated by multiplying the cost to produce one unit by the number of units you produced. For example, if it costs $10 to produce one unit and you made 30 of them, then the total variable cost would be 10 x 30 = $300.
What is Contribution Margin?
The contribution margin is the difference (more than zero) between the product’s selling price and its total variable cost. For example, if a suitcase sells at $125 and its variable cost is $15, then the contribution margin is $110. This margin contributes to offsetting fixed costs.
Unit Contribution Margin = Sales Price – Variable Costs
The average variable cost is calculated as your total variable cost divided by the number of units produced.
In general, lower fixed costs lead to a lower break-even point—but only if variable costs are not higher than sales revenue.
Why Does Your Business Need to Perform Break-Even Analysis?
A break-even analysis has broad uses on its own merit. But it’s also a critical element of financial projections for startups and new or expanded product lines. Use it to determine how much seed money or startup capital you’ll need, and whether you’ll need a bank loan.
More mature businesses use break-even analyses to evaluate their risks in a variety of activities such as moving innovative ideas to production, adding or deleting products from the product mix and other scenarios. One example is in budgeting the addition of a new employee. A break-even analysis will reveal how many additional sales it will take to break even on expenses associated with the new hire.
What Is a Standard Break-Even Time Period?
An acceptable break-even window is six to 18 months. If your calculation determines a break-even point will take longer to reach, you likely need to change your plan to reduce costs, increase pricing or both. A break-even point more than 18 months in the future is a strong risk signal.
When to Use a Break-Even Analysis
Basically, a business will want to use a break-even analysis anytime it considers adding costs. These additional costs could come from starting a business, a merger or acquisition, adding or deleting products from the product mix, or adding locations or employees.
In other words, you should use a break-even analysis to determine the risk and value of any business investment, especially when one of these three events occurs:
1. Expanding a business
Break-even points (BEP) will help business owners/CFOs get a reality check on how long it will take an investment to become profitable. For example, calculating or modeling the minimum sales required to cover the costs of a new location or entering a new market.
2. Lowering pricing
Sometime businesses need to lower their pricing strategy to beat competitors in a specific market segment or product. So, when lowering pricing, businesses need to figure out how many more units they need to sell to offset or makeup a price decrease.
3. Narrowing down business scenarios
When making changes to the business, there are various scenarios and what-ifs on the table that complicate decisions about which scenario to go with. BEP will help business leaders reduce decision-making to a series of yes or no questions.
How Do You Calculate the Break-Even Point?
ERP and accounting software with managerial accounting features will typically calculate your BEP for you, but you may want to understand what goes into that equation.
Break-even analysis formula
Break-even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)
You can also use our break-even analysis template.
Use Our Break-Even Analysis Template
Find your break-even point by using this break-even analysis template, customizable to your business.
Get the template
Break-even analysis example
Beth has dreams of opening a gourmet cupcake store. She does a break-even analysis to determine how many cupcakes she’ll have to sell to break even on her investment. She’s done the math, so she knows her fixed costs for one year are $10,000 and her variable cost per unit is $.50. She’s done a competitor study and some other calculations and determined her unit price to be $6.00.
$10,000 / ($6 – $0.50) = 1,819 cupcakes that Beth must sell in one year to break even
The Limitations of a Break-Even Analysis
The most important thing to remember is that break-even analysis does not consider market demand. Knowing that you need to sell 500 units to break even does not tell you if or when you can sell those 500 units. Don’t let your passion for the business idea or new product cause you to lose sight of that basic truth.
On the flip side, you’ll need to decide how much effort and time you’re willing to expend to reach the break-even point. For example, are you willing to invest a substantial percentage of your sales team’s time and effort over several months to reach the break-even point? Or, is producing and selling something else a better and more profitable use of time and effort?
If you find demand for the product is soft, consider changing your pricing strategy to move product faster. However, discounted pricing can actually raise your break-even point. If you’re not careful, you’ll move product faster at the lower price but will incur more variable costs to produce more units in order to reach your break-even point.
Plan & Forecast More Accurately
How to Lower Your Break-Even Point
There are two basic ways to lower your break-even point: lower costs and raise prices. But neither should be done in a vacuum. Weigh your options carefully in pricing methods and consumer psychology to make sure you don’t sell more product but lose money in the bargain.
Further, consider all elements of costs, such as the associated quality and delivery, before slashing them to prevent damage to your brand. Outsourcing products or service can also reduce costs when demand or volume increase.
Cash Flow Analysis: Basics, Benefits and How to Do It
Cash flow is the amount of cash and cash equivalents, such as securities, that a business generates or spends over a set time period. Cash on hand determines a company’s runway—the more cash on hand and the lower…
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In Pursuit of Profit: Applications and Uses of Break-Even Analysis
A break-even analysis is an essential element of financial planning. Here's how to apply it to your business.
The break-even analysis is one tool that every entrepreneur should use in their financial planning. It helps you understand your business’s revenue, expenses and cash flow – which is critical to keeping your doors open and your business profitable. Read on to learn more about what a break-even analysis is and how this essential form of financial planning helps business owners make informed decisions.
What is a break-even analysis?
A break-even analysis is a financial tool that helps you determine at which stage your company, service or product will be profitable. It is a financial calculation used to determine the number of products or services a company must sell to cover its expenses, especially the fixed costs.
Here’s an example of the elements that go into a break-even analysis:
- Fixed costs: These are the costs that stay the same no matter how much the business sells, also referred to as overhead costs. They include utilities, bills, salaries and wages, rent, and insurance.
- Variable costs: Variable costs are based on a business’s sales. They can include additional labor from independent contractors, materials and payment processing fees.
- Average price: This is the average amount you will charge for your products and services.
What is the break-even point formula?
Taken together, these elements create a formula known as the break-even point formula. It is a relatively simple calculation, but it is critical in planning for profitability.
Fixed Costs / (Average Price – Variable Cost) = Break-Even Point
The term “break-even” refers to a situation where you are neither making nor losing money, but all of your costs have been covered. With a break-even analysis, you can determine when your company will generate enough revenue to cover its expenses and earn a profit. The same holds true for a particular product or service. This data is often used for financial projections.
Examples of break-even analysis
Here are two examples of the break-even point formula.
The price of one of the products you sell is $100. Your total fixed costs are $10,000 per month, and the variable cost is $50 per product. The formula to calculate how many products you must sell to break even would look like this:
$10,000 / ($100 – $50) = 200
Based on the formula, you would need to sell 200 products to cover your costs, effectively breaking even. To be profitable, you would have to sell at least 201 products.
In this example from the Corporate Finance Institute , a water company has total fixed costs of $100,000. The variable costs of making one bottle of water is $2 per unit, and each bottle is sold for $12. Using the break-even analysis formula, you can see that the company must sell 10,000 bottles to recoup its costs and 10,001 bottles to begin earning a profit:
$100,000 / ($12 – $2) = 10,000
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Why is a break-even analysis important?
A break-even analysis informs you of the bare minimum performance your business must meet to avoid losing money. It also helps you understand at which point you’ll generate profits so you can set production goals accordingly.
You can use this information when your business is in the planning stages to determine whether your idea is feasible or not. Then, once your business is established, you can use a break-even analysis to develop direct cost structures and to identify opportunities for promotions and discounts.
While there is a lot to know about conducting a break-even analysis, let’s focus on the three most common uses.
1. It helps you identify the point of profitability.
A business that doesn’t turn a profit could take a turn for the worse at any time. This is why every company needs to focus on its point of profitability. Ask yourself these questions:
- How much revenue do I need to generate to cover all my expenses?
- Which products or services generate a profit?
- Which products or services are sold at a loss?
A company’s goal is to become profitable as soon as possible. To ensure that you are on the right track, it is necessary to focus on your numbers upfront. If you don’t calculate the break-even points for your products or services, you risk not generating a profit (or not as much of a profit as you believed you would).
2. It ensures that you properly price a product or service.
When most people think about pricing, they primarily take into account how much their product costs to create and fail to consider overhead costs – underpricing their products as a result. Finding your break-even point will help you price your products correctly. You will know where you need to set your margins to generate the right amount of revenue to break even and begin turning a profit.
If you offer only a couple of products or services, determining your break-even point is simple. It becomes more challenging as your service offerings and production increase.
Image via Business Tool Pro
As you determine your break-even point for a product or service, ask yourself the following questions:
- What is the total cost?
- What are the fixed costs?
- What are the variable costs?
- What is the total variable cost?
- What is the cost of any raw materials?
- What is the cost of labor?
Last but not least, you should ask yourself, “What adjustments can I make to lower the cost of manufacturing or generate the end result I envision?” For instance, you may be able to source some products from a cheaper distributor, or perhaps make some changes to your hiring process to save on labor costs.
3. It gives you the information you need to implement the best strategy moving forward.
Using your break-even analysis, you can create a strategy for the future. If your business’s profitability is determined by the success of one or more products, the break-even point for each product provides a timeline for the company, which can help you implement a better overall financial strategy that fits the projected costs and profits.
This analysis can also help you determine ways to speed up your company’s break-even point, such as reducing your overall fixed costs, reducing the variable costs per unit, improving the sales mix by selling more of the products that have larger contribution margins, and increasing the prices (as long as it doesn’t cause the number of units sold to decline significantly).
When should I use a break-even analysis?
There are many situations in running a business where a break-even analysis comes in handy. According to Rick Vazza, a CFA and CFP and the president of Driven Wealth Management , you should use a break-even analysis to answer the following questions about your business:
- How much of my product or service do I need to sell per month?
- How much volume do I expect to sell?
- What price makes those figures match my break-even calculation?
- What price allows me to generate a reasonable profit?
Your goal is to get an accurate look at what your profit, net cash flow and finances will be.
“It’s much easier for people to decide whether they can beat that minimum than guessing how many sales they may make,” said Rob Stephens, founder of CFO Perspective .
Here are three times when you should consider performing a break-even analysis.
If you are expanding your business
Stephens suggests using a break-even analysis to get a reality check on how long it will take any planned investments or changes in your business to become profitable.
“These investments might be a new product or location,” Stephens said. “I’ve done break-even calculations many times for modeling the minimum sales needed to cover the costs of a new location.”
If you need to lower your pricing
This analysis is also helpful when you need to lower your prices to beat a competitor. “You can also use break-even analysis to determine how many more units you need to sell to offset a price decrease,” Stephens said. “The most common use of break-even analysis in my career has been modeling price changes.”
If you want to narrow down your options
When making changes to your business, you may be bombarded with various scenarios and possibilities, which can be overwhelming when you’re trying to make a decision. Stephens suggests using a break-even analysis to reduce your decisions to scenarios with straightforward yes-or-no questions like, “Can we do better than the minimum needed for success?”
More financial planning resources
Here are four additional resources to help you better understand how to conduct a break-even analysis and use the data accordingly:
- University of Baltimore’s break-even calculators
- SCORE’s break-even analysis template
- Colorado State University’s Break-Even Method of Investment Analysis
Julianna Lopez contributed to the reporting and writing in this article.
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Every business relies on a steady cash flow to ensure its growth and success. This flow covers payroll, inventory costs, monthly payment costs, and other draws. Our break-even calculator can help you as a business owner to measure your cash flow, allowing you to take necessary action to ensure that your operations are running smoothly. It can mark your break-even point, for example, which lets you make future financial decisions as well as other variables.
If you run a cupcake shop, how many cupcakes do you think you’ll sell?
You will break even after selling 0 units for $
You won’t break even with the current numbers.
What Does Break-Even Mean?
If you’re a new business owner or plan on starting one, there are a few financial things you should know. The first is what break-even means. This point is when total cost and total revenue are equal. In other words, at the break-even point, your business has reached a level of production where costs of production equal the revenue of your products.
As you can see from our calculator, you’ll need to know four important variables:
- The monthly amount of units you expect to sell.
- How much you’ll charge per unit.
- The cost of producing each unit.
- How much your fixed monthly costs will be.
Most of these are self-explanatory, but here is some detailed information.
Expected Unit Sales
This is the number of units that your business is expected to sell within a given period, such as per month, quarter, six-month window, or year.
Price Per Unit
This is the price per unit that you’ll sell.
Cost Per Unit
This is the cost of producing each unit.
This cost doesn’t change with the increase or decrease in the amount goods sold or produced. They are expenses that need to be paid off by the company, free of any business activity. This means that fixed costs are mostly indirect and don’t apply to the production of goods.
Other Terms to Know
This is the revenue minus total costs of production and other factors needed to run your business.
This is the sum of all costs by a company resulting from the production of a certain amount of output of a good or service.
The total revenue is the complete amount of sales of goods and services. One thing to keep in mind is the marginal revenue, which measures any increases in revenue resulting from selling more products and services.
Total Variable Costs
The total variable cost is the total number of expenses that change depending on how much the business produces or sells a product or service. Variable costs increase or decrease depending on sales volumes.
Variable Unit Costs
A variable unit cost is the production cost for any units that are affected by changes in a company’s activity level (output).
How Our Break-Even Calculator Works
Our break-even calculator is specifically designed to make its use as convenient and seamless as possible. We understand that dealing with so many financial variables can be tricky and even scary at times. Our calculator eliminates that fear since all you have to do is input all of the necessary variables in each appropriate box and the calculator will do the rest.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Break-Even Calculator FAQs
In order to calculate your company’s break-even point, you’ll need to know your fixed cost per unit, average selling price per unit, variable cost per unit, and expected unit sales. These three are important when using our calculator.
Knowing your break even point allows you to take a step back and reassess what you’re doing as a business owner to ensure that your company stays afloat in a competitive market without burning a hole in your pocket.
Your break-even point will depend on your business model. The general consensus is that the lower the break-even point, the better. If your break-even point is low, you have a higher chance of generating a profit.
Fixed costs tend to remain the same no matter what your production output is. These costs include rent, interest payments, business insurance, etc. On the other hand, variable costs change based on your output and are usually materials, labor, commissions, etc.
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Break-Even Analysis Explained - Full Guide With Examples
Did you know that 30% of operating small businesses are losing money? Running your own business is trickier than it sounds. You have to plan ahead carefully to break-even or be profitable in the long run.
Building your own small business is one of the most exciting, challenging, and fun things you can do in this generation.
To start and sustain a small business it is important to know financial terms and metrics like net sales, income statement and most importantly break-even point .
Performing break-even analysis is a crucial activity for making important business decisions and to be profitable in business.
So how do you do it? That is what we will go through in this article. Some of the key takeaways for you when you finish this guide would be:
- Understand what break-even point is
- Know why it is important
- Learn how to calculate break-even point
- Know how to do break-even analysis
- Understand the limitations of break-even analysis
So, if you are tired of your nine-to-five and want to start your own business, or are already living your dream, read on.
What is Break-Even Point?
Small businesses that succeeds are the ones that focus on business planning to cross the break-even point, and turn profitable .
In a small business, a break-even point is a point at which total revenue equals total costs or expenses. At this point, there is no profit or loss — in other words, you 'break-even'.
Break-even as a term is used widely, from stock and options trading to corporate budgeting as a margin of safety measure.
On the other hand, break-even analysis lets you predict, or forecast your break-even point. This allows you to course your chart towards profitability.
Managers typically use break-even analysis to set a price to understand the economic impact of various price and sales volume calculations.
The total profit at the break-even point is zero. It is only possible for a small business to pass the break-even point when the dollar value of sales is greater than the fixed + variable cost per unit.
Every business must develop a break-even point calculation for their company. This will give visibility into the number of units to sell, or the sales revenue they need, to cover their variable and fixed costs.
Importance of Break-Even Analysis for Your Small Business
A business could be bringing in a lot of money; however, it could still be making a loss. Knowing the break-even point helps decide prices, set sales targets, and prepare a business plan.
The break-even point calculation is an essential tool to analyze critical profit drivers of your business, including sales volume, average production costs, and, as mentioned earlier, the average sales price. Using and understanding the break-even point, you can measure
- how profitable is your present product line
- how far sales drop before you start to make a loss
- how many units you need to sell before you make a profit
- how decreasing or increasing price and volume of product will affect profits
- how much of an increase in price or volume of sales you will need to meet the rise in fixed cost
How to Calculate Break-Even Point
There are multiple ways to calculate your break-even point.
Calculate Break-even Point based on Units
One way to calculate the break-even point is to determine the number of units to be produced for transitioning from loss to profit.
For this method, simply use the formula below:
Break-Even Point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)
Fixed costs are those that do not change no matter how many units are sold. Don't worry, we will explain with examples below. Revenue is the income, or dollars made by selling one unit.
Variable costs include cost of goods sold, or the acquisition cost. This may include the purchase cost and other additional costs like labor and freight costs.
Calculate Break-Even Point by Sales Dollar - Contribution Margin Method
Divide the fixed costs by the contribution margin. The contribution margin is determined by subtracting the variable costs from the price of a product. This amount is then used to cover the fixed costs.
Break-Even Point (sales dollars) = Fixed Costs ÷ Contribution Margin
Contribution Margin = Price of Product – Variable Costs
Let’s take a deeper look at the some common terms we have encountered so far:
- Fixed costs: Fixed costs are not affected by the number of items sold, such as rent paid for storefronts or production facilities, office furniture, computer units, and software. Fixed costs also include payment for services like design, marketing, public relations, and advertising.
- Contribution margin: Is calculated by subtracting the unit variable costs from its selling price. So if you’re selling a unit for $100 and the cost of materials is $30, then the contribution margin is $70. This $70 is then used to cover the fixed costs, and if there is any money left after that, it’s your net profit.
- Contribution margin ratio: is calculated by dividing your fixed costs from your contribution margin. It is expressed as a percentage. Using the contribution margin, you can determine what you need to do to break-even, like cutting fixed costs or raising your prices.
- Profit earned following your break-even: When your sales equal your fixed and variable costs, you have reached the break-even point. At this point, the company will report a net profit or loss of $0. The sales beyond this point contribute to your net profit.
Small Business Example for Calculating Break-even Point
To show how break-even works, let’s take the hypothetical example of a high-end dressmaker. Let's assume she must incur a fixed cost of $45,000 to produce and sell a dress.
These costs might cover the software and materials needed to design the dress and be sure it meets the requirement of the brand, the fee paid to a designer to design the look and feel of the dress, and the development of promotional materials used to advertise the dress.
These costs are fixed as they do not change per the number of dresses sold.
The variable costs would include the materials used to make each dress — embellishment’s for $30, the fabric for the body for $20, inner lining for $10 — and the labor required to assemble the dress, which amounted to one and a half hours for a worker earning $50 per hour.
Thus, the unit variable costs to make a single dress is $110 ($60 in materials and $50 in labor). If she sells the dress for $150, she’ll make a unit margin of $40.
Given the $40 unit margin she’ll receive for each dress sold, she will cover her $45,500 total fixed cost will be covered if she sells:
Break-Even Point (Units) = $45,000 ÷ $40 = 1,125 Units
You can see per the formula , on the right-hand side, that the Break-even is 1,125 dresses or units
In other words, if this dressmaker sells 1,125 units of this particular dress, then she will fully recover the $45,000 in fixed costs she invested in production and selling. If she sells fewer than 1,125 units, she will lose money. And if she sells more than 1,125 units, she will turn a profit. That’s the break-even point.
What if we change the price?
Suppose our dressmaker is worried about the current demand for dresses and has concerns about her firm’s sales and marketing capabilities, calling into question her ability to sell 1,125 units at a price of $150. What would be the effect of increasing the price to $200?
This would increase the unit margin to $90.Then the number of units to be sold would decline to 500 units. With this information, the dressmaker could assess whether she was better off trying to sell 1,125 dresses at $150 or 500 dresses at $200, and priced accordingly.
What if we want to make an investment and increase the fixed costs?
Break-even analysis also can be used to assess how sales volume would need to change to justify other potential investments. For instance, consider the possibility of keeping the price at $150, but having a celebrity endorse the dress (think Madonna!) for a fee of $20,000.
This would be worthwhile if the dressmaker believed that the endorsement would result in total sales of $66,000 (the original fixed cost plus the $20,000 for Ms. Madonna).
With the Fixed Costs at $66,000 we see, it would only be worthwhile if the dressmaker believed that the endorsement would result in total sales of 1,650 units.
In other words, if the endorsement led to incremental sales of 525 dress units, the endorsement would break-even. If it led to incremental sales of greater than 525 dresses, it would increase profits.
What if we change the variable cost of producing a good?
Break-even also can be used to examine the impact of a potential change to the variable cost of producing a good.
Imagine that our dressmaker could switch from using a rather plain $20 fabric for the dress to a higher-end $40 fabric, thereby increasing the variable cost of the dress from $110 to $130 and decreasing the unit margin from $40 to $20. How much would your sales need to increase to compensate for the extra cost?
Suppose the Variable Cost is $130 (and the Fixed Cost is $45,000 – our dressmaker can’t afford to have nice fabric plus get Ms. Madonna). It would make better sense to switch to the nicer fabric if the dressmaker thought it would result in sales of 2,250 units, an additional 1125 dresses, which is double the number of initial sale numbers.
You likely aren’t a dressmaker or able to get a celebrity endorsement from Ms. Madonna, but you can use break-even analysis to understand how the various changes of your product, from revenue, costs, sales, impact your small business’s profitability .
What Are the Benefits of Doing a Break-even Analysis?
Smart Pricing : Finding your break-even point will help you price your products better. A lot of effort and understanding goes into effective pricing, but knowing how it will affect your profitability is just as important. You need to make sure you can pay all your bills.
Cover Fixed Costs : When most people think about pricing, they think about how much their product costs to create. Those are considered variable costs. You will still need to cover your fixed costs like insurance or web development fees. Doing a break-even analysis helps you do that.
Avoid Missing Expenses : When you do a break-even analysis, you have to lay out all your financial commitments to figure out your break-even point. It’s easy to forget about expenses when you’re thinking through a business idea. This will limit the number of surprises down the road.
Setting Revenue Targets : After completing a break-even analysis, you know exactly how much you need to sell to be profitable. This will help you set better sales goals for you and your team.
Decision Making : Usually, business decisions are based on emotion. How you feel is important, but it’s not enough. Successful entrepreneurs make their decisions based on facts. It will be a lot easier to decide when you’ve put in the work and have useful data in front of you.
Manage Financial Strain : Doing a break-even analysis will help you avoid failures and limit the financial toll that bad decisions can have on your business. Instead, you can be realistic about the potential outcomes by being aware of the risks and knowing when to avoid a business idea.
Business Funding : For any funding or investment, a break-even analysis is a key component of any business plan. You have to prove your plan is viable. It’s usually a requirement if you want to take on investors or other debt to fund your business.
When to Use Break-even Analysis
Starting a new business.
If you’re thinking about a small online business or e-commerce, a break-even analysis is a must. Not only does it help you decide if your business idea is viable, but it makes you research and be realistic about costs, as well as think through your pricing strategy.
Creating a new product
Especially for a small business, you should still do a break-even analysis before starting or adding on a new product in case that product is going to add to your expenses. There will be a need to work out the variable costs related to your new product and set prices before you start selling.
Adding a new sales channel
If you add a new sales channel, your costs will change. Let's say you have been selling online, and you’re thinking about opening an offline store; you’ll want to make sure you at least break-even with the brick and mortar costs added in. Adding additional marketing channels or expanding social media spends usually increases daily expenses. These costs need to be part of your break-even analysis.
Changing the business model
Let's say you are thinking about changing your business model; for example, switching from buying inventory to doing drop shipping or vice-versa, you should do a break-even analysis. Your costs might vary significantly, and this will help you figure out if your prices need to change too.
Limitations of Break-even Analysis
- The Break-even analysis focuses mostly on the supply-side (i.e., costs only) analysis. It doesn't tell us what sales are actually likely to be for the product at various prices.
- It assumes that fixed costs are constant. However, an increase in the scale of production is likely to lead to an increase in fixed costs.
- It assumes average variable costs are constant per unit of output, per the range of the number of sales
- It assumes that the number of goods produced is equal to the number of goods sold. It believes that there is no change in the number of goods held in inventory at the beginning of the period and the number of goods held in inventory at the end of the period
- In multi-product companies, the relative proportions of each product sold and produced are fixed or constant.
So that's a wrap. Hope you found this article interesting and informative. Feel free to subscribe to our blog to get updates on awesome new content we publish for small business owners.
Break-even analysis is infinitely valuable as it sets the framework for pricing structures, operations, hiring employees, and obtaining future financial support.
- You can identify how much, or how many, you have to sell to be profitable.
- Identify costs inside your business that should be alleviated or eliminated.
Remember, any break-even analysis is only as strong as its underlying assumptions.
Like many forecasting metrics, break-even point is subject to it's limitations; however it can be a powerful and simple tool to provide a small business owner with an idea of what their sales need to be in order to start being profitable as quickly as possible.
Lastly, please understand that break-even analysis is not a predictor of demand .
If you go to market with the wrong product or the wrong price, it may be tough to ever hit the break-even point. To avoid this, make sure you have done the groundwork before setting up your business.
Head over to our small business guide on setting up a new business if you want to know more.
Want to calculate break even point quickly? Use our handy break-even point calculator.
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Break-Even Analysis Explained—How to Find the Break-Even Point
Posted november 2, 2022 by kiara taylor.
Conducting a break-even analysis is a crucial tool for small business owners. If you’re planning on launching a business, writing a business plan , or just exploring a new product, knowing your break-even point can tell you whether or not a product or service is a good idea.
In this guide, we’ll cover what a break-even point is, why it’s critical to calculate, how to calculate it, and additional factors you should consider.
What is the break-even point?
The break-even point is where an asset’s market price equals its original cost. Put another way; the break-even point is when the total revenues of a certain production level equal the total expenses of producing that product. For small business owners, it’s essentially the amount that you need to earn in order to cover your costs.
Why you should know your break-even point
So, why is knowing your break-even point so important? Here are a few important reasons to consider.
Risk comes in various forms , but break-even points can help you understand the viability of certain products before they’re even launched.
For example, before even sending an order to a factory, you can already know how many units you need to sell and what expenses will go into making that product. Understanding this is key whether you’re launching a business for the first time or starting a new product line.
Identify unseen expenses
Running a break-even analysis forces you to outline all potential expenses associated with an initiative. Expenses that you’d otherwise miss without it. Usually, these expenses come from the fixed and variable costs of production. In this process, you can often identify unexpected expenses that you may not have considered before.
Appropriately price your products/services
Because your break-even point concerns the price relationship to your expenses, you can calculate different break-even points based on sold units or different pricing schemes. For example, you may find that your product is unprofitable at a certain price point except at extremely large scales.
If that’s the case, you can explore higher price points. However, it’s important that you do not do this in isolation. Instead, use this exercise to understand potential pricing options and begin testing them with your target customers .
Prepare for funding
If you’re seeking funding for your business, this information is often expected or required by lenders and investors . It helps them gauge the viability of your idea and determine what level of funding is appropriate. For you as a business owner, it can help you determine how much funding you think you’ll need and even identify how you’ll use those funds.
How to calculate the break-even point
To calculate your break-even point, you’ll need to know the following:
- Fixed costs: Expenses that remain consistent no matter your sales volume.
- Variable costs: Expenses that change depending on your sales/production volume.
- Sales price: The price that you intend to sell the product/service for.
Break-even point formula
The break-even point is calculated using your fixed costs and your contribution margin. The contribution margin is the selling price of the product minus the total variable costs. Your selling price is usually the amount you place on any customer invoices.
The contribution margin formula is:
Contribution Margin = Selling Price – Total Variable Costs
Once you have the contribution margin, you then take the total fixed costs per unit and divide those costs by the contribution margin. This will give you the break-even number of units required to offset your costs.
The break-even point formula is:
Break-Even Point = Fixed Costs / Contribution Margin
Break-even point example
Now that you know the formula for calculating your break-even point let’s put it into practice.
Imagine you are the owner of a small paper company and considering adding a new line of paper to your available products. You expect to sell a ream of paper for $5.00.
The variable costs of the ream of the paper include:
- $1.00 for the paper itself
- $0.50 for the packaging of the ream
- $0.50 of costs to package each ream
According to this information, you have $2.00 in variable costs. Using the formula mentioned above, we can calculate the contribution margin for your paper ream:
$5.00 – $2.00 = $3.00
Next, we’ll incorporate fixed costs to determine how many units need to be sold. After holding an office meeting in the conference room, you determine that the following fixed costs are associated with producing reams of paper:
- $50.00 in salaries
- $50.00 in office rent
- $50.00 for monthly shipments from the paper factory
Your total fixed costs come to: $50.00 + $50.00 + $50.00 = $150.00.
Lastly, we’ll calculate the break-even point: $150.00 / $3.00 = 50 units. To break even, you would need to sell 50 reams of paper.
Maximizing your break-even point formulas
You can also utilize this calculation to figure out your break-even point in dollars. This is done by dividing the total fixed costs by the contribution margin ratio. You can figure out your contribution margin ratio by taking the contribution margin per unit and dividing it by the sales price.
Your contribution margin ratio using the data from the above example is:
$3.00 (your contribution margin) / $5.00 (price per one ream of paper) = 60%.
Finally, divide your total fixed costs ($150.00) by your contribution margin ratio (60%) to calculate the break-even point in dollars:
$150.00 / 60% = $250.00 in sales
You can confirm your findings by multiplying your break-even point in units (50) by the sales price ($5.00):
50 x $5.00 = $250.00
What is a standard break-even time period?
The standard break-even period is hard to predict and fully depends on your business. However, once you know your break-even point, you can gauge the time it will take to break even more accurately.
Your break-even period is the amount of time it takes you to sell enough units to break even. This means that the only thing holding back your ability to break even is how fast you sell your units.
The formula to calculate your break-even time period is:
Break-Even Time Period = Break-Even Units / Amount Sold per Period (Period)
If we return to the paper company example, we can estimate what the break-even period is. After reviewing your financials, you learn that the average number of reams you expect to sell daily is 5. Now, take your number of break-even units (50) and divide them by the amount sold in a given period (5):
50 / 5 = 10. Under this analysis, you would break even in approximately 10 days.
However, it’s important to remember that fixed costs, which are an important part of calculating your break-even point, may accumulate faster than you can sell your product. In that case, you’ll need to factor this into your analysis.
How to lower your break-even point
Everyone wants to lower their break-even point because it typically leads to greater profitability at a faster rate. But how do you lower your break-even point? The key thing to remember is that it’s a ratio of your fixed and variable costs. To reduce your break-even point, you’ll need to lower one or both.
One of the most efficient ways to reduce your break-even point is to start by reducing variable costs. Keep in mind that variable costs are associated with each unit. Other fixed costs, those that exist regardless, like the $20-$80 you pay for your employees’ no medical life insurance every month, can be more difficult to eliminate because they are essential.
What you can do with a break-even analysis
Conducting an initial break-even analysis is incredibly useful when starting a business. But, did you know that you can use it on an ongoing basis as part of your management process ? Here are a few key uses you can leverage.
Determine if your prices are correct
A break-even analysis can be used to continuously audit and fine-tune your pricing strategy. If you find sales are missing expectations, you can reference this calculation to easily understand what quantities must be sold if you decide to adjust the price.
Explore current fixed and variable costs
You can also explore how different costs impact your bottom line. At the end of the day, your business needs to know what costs are impacting its ability to generate revenue. A break-even analysis can help you understand whether some products may be costing you more money than their worth. For example, products with low contribution margins or ratios might be too expensive to keep in production.
Narrow down financial scenarios
Finally, you can use your break-even analyses as part of any forecast scenarios that you explore. By changing numbers in your formula, you can test different types of prices and quantities based on perceived consumer interest. This can help inform a larger analysis of your sales, cash, and expenses based on how reasonable your price and volume adjustments are.
Other metrics to consider
Now that you understand break-even points and break-even analysis, you’ll be able to put them to work for your business. Remember, this is just a piece of measuring business performance and there are other valuable metrics you should be tracking. You can do this manually with spreadsheets, leverage budgeting and accounting software, or better explore future performance with LivePlan’s performance tracking and forecasting features .
Whatever option you choose, the important thing is that you are aware of these metrics and actively using them. It will help you better understand the health of your business, make more strategic decisions, and ultimately grow your business.
Posted in growth & metrics.
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