All business owners need to be aware of their break-even point — that is, what they need to sell in order to cover their operating costs.
Once you’ve reached your break-even point, it’s time to celebrate: your business is no longer in the red, and you are officially earning a profit.
We want to show you how to calculate your break-even point so you can make business decisions that support greater growth.
Why your break-even point matters
Business owners who attempt to run a business without knowing whether or when they’ll be profitable probably won’t be in business long.
Knowing your break-even point comes in handy whenever you’re making plans to invest in your company’s growth, or making a decision that will have an impact on profits.
Another key advantage of knowing exactly how much you have to earn to start generating profits is improved accuracy of your budgets and forecasts.
What are your fixed costs?
The first step to calculating your break-even point is to list the predictable, ongoing monthly expenses required to run your business.
Examples of fixed costs include:
Rented or leased office space
Rented or leased retail space
Utilities (e.g. heat, electricity, phone service, internet)
Do the best you can to include the most accurate numbers on your break-even spreadsheet – and be sure to add an additional 10% to cover any cost increases. Also have a provision to cover any unforeseen expenses that might be incurred.
List your variable costs
You’ll also want to take into account the business expenses that vary month to month. One way to do this is to calculate an average monthly cost by tracking your variable expenses over a two to three month period.
Examples of items you’ll want to include monthly estimates for are:
Interest fees (calculated on your business credit cards or lines of credit)
Based on your fixed and variable monthly costs, you can now determine how much you need to sell in order to reach your break-even point.
Try this simple break-even formula
To find the break-even point for any product or service you offer, enter the following numbers in the formula below:
your company’s fixed overhead costs
the price of each item for sale
each unit’s variable costs
Fixed costs ÷ (unit sales price - variable costs)
As an example, let’s calculate the break-even point for a web designer offering fixed rate website packages priced at $5,000/each.
Fixed operating expenses: $10,000
Variable expenses/package: $1,000
Current sales price: $5,000/package
$10,000/($5,000 - $1,000)
$10,000/($4,000) = 2.5
According to this calculation, the web designer would need to sell 2.5 website packages to break even and start earning a profit.
In order to improve profitability, the designer may decide to cut expenses, switch to lower-priced business service providers, raise her rates, or try to sell her customers new “add on” services.
To ensure you’re always making business decisions based on the most accurate, up to date info, make it a habit to update your break even analysis each quarter. You also need to understand that there is a difference between profit and cash. As such, you need to consider your cash flow requirements in conjunction with your break even analysis as part of any business decision making process and to ensure the business can survive. You may be breaking even, but not have sufficient cash flow to operate your business. This may be because debtors have not yet paid you or you have loan repayments etc.
If you have any questions or would like help calculating your break-even point, please get in touch with us!