Do you know your company’s break-even point? If not, you can massively improve your chances of business success by sitting down and crunching some numbers.
A break-even analysis can help you determine how much money you need to become profitable. While this may not apply to all businesses, it’s an important tool to help you understand your financial situation, and it can guide you to make better business decisions.
In this article, we’ll dive into what a break-even point analysis is and how you can calculate it, as well as give some examples and some tricks and tips you can apply along the way.
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What is a break-even analysis?
Simply put, a break-even analysis is a financial calculation that will help you figure out how much money you need to earn before your business idea officially crosses into “profitable” territory.
To become profitable, you need to be able to cover your daily costs of production and operation, and then earn some extra on top of that.
Determining your break-even point is also helpful for companies that require a lot of capital and upfront investment to get up and running, like brick-and-mortar stores and businesses with a lot of equipment.
To do a break-even point analysis, you’ll need to understand two key types of cost: fixed and variable.
- Fixed cost: an expense that’s always the same number every month, no matter how many sales you make (e.g., real estate rent, insurance, business taxes)
- Variable cost: an expense that increases or decreases based on how many sales you make (e.g., production costs like raw materials, payroll for hourly employee labor, credit card processing fees)
Advantages of a break-even analysis
There are plenty of advantages to performing a break-even point analysis. Here are a few:
Smarter pricing. You may discover that your prices simply aren’t enough to cover your costs, despite the other factors that went into choosing those prices. At the end of the day, profitability is always the number one driver.
Full financial understanding. It’s easy to overlook expenses when you have a lot of things to consider. But a break-even analysis is a detailed look at your business, and often uncovers things you’ve been missing.
Precise sales goals. Many businesses learn exactly how many sales they need to make per day, week, month, etc., as opposed to the general goal of as many sales as possible (which can be unhelpful when you’re experiencing financial strain!).
Better business decisions. Sometimes, a new business idea seems like a great path. But once you do the math, you may learn that it’s not wise financially. A break-even analysis can help you choose more financially sound options.
How to calculate break-even point
A break-even point analysis has a clear formula: your fixed costs divided by your average unit price minus your variable costs.
This may seem confusing, so let’s work through it.
Essentially, you need to figure out how much profit you make on each unit you sell. For example, a unit can be a candle if you’re a candle maker, a lawn mowing service if you have a landscaping company, or a website package if you have a web development company.
Once you know your profit per unit, divide that number by your fixed costs (the basic costs to run your business that stay the same every month).
The leftover profit is your contribution margin ratio. It’s called the contribution margin ratio because this amount contributes sales dollars to your fixed costs.
Note: You can download a free break-even analysis template from Shopify. The US Small Business Administration (SBA) also offers a free break-even calculator.
Collect your business’s data
Gather every single expense you have as a business, including:
- Fixed costs: Property rent, insurance, software subscriptions, set labor like your accountant’s monthly retainer fee or your salary-based employee pay, etc.
- Variable costs: Raw materials, payment processing fees, non-fixed labor like hourly employee earnings and commission, delivery costs, product packaging costs, etc.
- Average sales price: Calculate a rough average sales price across all your products and services. If you haven’t set firm prices yet, just make an educated guess and you can tweak it later if the numbers don’t work.
Don’t let a single expense slip through the cracks. This might include variable costs like a set of branded cocktail napkins for a special catering event, or a promotional gift you’re including with your ecommerce orders.
Plug in the numbers
Now it’s time to put those numbers into the spreadsheet. We weren’t exaggerating when we said it’s handy: once you add your figures, it’ll calculate your total fixed costs and variable costs. Once you add your average selling price, the spreadsheet will automatically calculate the final break-even point.
Your final result will show in cell E3, “Break-Even Units.” That’s how many units you need to sell to hit your break-even point.
The beauty of this spreadsheet is that you can make as many changes and experiments as you want until you reach a configuration that feels feasible and sound for your business.
Break-even-analysis examples: 4 use cases
There are many scenarios for when it makes sense to do a break-even analysis. Examples include:
1. Starting a new business
Before implementing a business idea, you’ll want to conduct a break-even analysis. Not only will it help you determine whether your idea is viable, it will push you to be realistic about costs and think through your revenue-generating strategy.
2. Changing your business model
If you’re considering changing your business model—for example, switching from carrying products to printing them on demand—you should perform a break-even analysis. This will help you determine whether your prices need to change in response to the significant changes in your startup costs after adopting the new model.
3. Developing a new product
Before committing to a new product, you should do a break-even analysis. This is necessary to determine the variable costs related to the new item and set prices. Even if your fixed costs, like utility bills, stay the same, you should still calculate the break-even point to get an idea of the number of units you’ll need to sell to reach profitability.
4. Adding a new sales channel
Adding a new sales channel can impact your costs, even if your prices remain unchanged. For instance, if you’ve been selling online and now plan to have a pop-up shop, it’s crucial to ensure that you break even to avoid financial strain that may harm your business.
The same applies to new online sales channels like shoppable posts on TikTok. If you’re planning any additional costs to promote the channel (such as TikTok ads), your break-even analysis should account for those expenses.
Tips to lower your break-even point
Does your break-even point seem unattainable or far-fetched? This can make you decide against starting a new business. But instead of forgoing the idea of entrepreneurship, you can make some adjustments to lower your break-even point.
1. Lower variable costs
Reducing your variable expenses can be challenging, especially for new businesses. However, as you grow, it becomes easier to lower these costs. You can attempt to do so by talking to your suppliers, switching to different suppliers, or improving your production method. For instance, you may find that using packing peanuts instead of bubble wrap can lower your shipping costs for delicate items.
2. Raise your prices
By increasing your prices, you will require fewer sales to reach breakeven. Each unit sold will bring in a higher profit margin. When considering a price hike, consider what the market will accept and what customers will expect. While you’ll need fewer sales, you still must sell enough. If you charge more, customers may expect improved quality or better customer service.
3. Lower fixed costs
Examine the possibility of reducing your fixed costs. The lower they are, the fewer units you need to sell to break even. For instance, if opening a retail store isn’t financially feasible, consider selling through an online platform. Changes like these can significantly lower your fixed costs and, consequently, your break-even point.
Break even to break through
A break-even point analysis doesn’t take a lot of work—it’s a fairly simple financial calculation that can have huge impacts on your business in the long run.
This tool helps business owners and leaders to have a more solid grasp on a company’s finances. Not only does this help with the immediate goal of becoming profitable as soon as possible, but it also helps to steer business decisions for the entire lifetime of the company.
If you’ve never performed a break-even analysis, it’s never too late. Take an hour or two (or perhaps more, depending on the complexity of your business) to crunch the numbers and see where you are and where you can go.
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Want to learn more?
- Small Business Accounting: How to Manage Your Own Books
- Financial Statement: What Is It and Why It Matters
- How to Register a Business in the USA
- 10-Step Formula to Achieve Financial Freedom