When you’re starting a new business or launching a new product or service, hitting your break-even point (BEP) is a time for celebration. It indicates that you’re rising up the ladder of success and your idea is commercially viable.
But how do you even calculate what your break-even point is?
For new business owners, current business owners, and those looking for investors, a break-even analysis can help show how quickly you will start becoming profitable, or how quickly you did break-even. Both will show you better indicators of success.
Read on to learn how to calculate your break-even point and all the things you need to consider when executing the break-even point formula.
What is a break-even analysis?
Break-even analysis (BEA) is a financial calculation that shows the point where you’ve sold enough units of product or service to cover all of your fixed and variable costs involved in creating these units. It’s where your business is at a “zero profit and loss” position.
It can also be a motivational tool, showcasing how close you may be to your break-even point. It will guide you to take the right steps to start making profit!
What are the benefits of doing a break-even analysis?
Pretty much every kind of business can benefit from a break-even analysis.
- Help with budgeting - It can show where you may need to cut costs or find more efficient ways to produce your units.
- Set selling price - Raising or lowering your sales price can move the needle with your break-even point. Can you lower your prices a bit to get more sales?
- Future-proofing - You can use this analysis to see if your business venture will remain profitable with rising costs.
- Motivational and target setting - You can set sales targets and motivate your staff to try harder to hit break-even faster.
- The margin of safety - Knowing where your break-even point is, and comparing how your sales are tracking to get there, you can see how the business is going, and if you’ll fall short of break-even before your budget runs out.
These benefits above flow onto other parts of your business too. Knowing your fixed costs, and seeing where you have opportunities to decrease it, will improve your profits and bring your BEP closer.
This kind of analysis can help you when variable costs become a factor. Can you switch to a different supplier, for example, to maintain sales momentum?
A BEA benefits small and medium businesses that may not have done such a financial analysis on themselves before. They’re usually stuck in the day to day, focusing on the daily activity that will help them make a sale. They don't take the time to sit back, look to the horizon and make strategic plans.
A good BEA can help businesses like yours learn to price smarter, potentially catch expenses you never knew you had, help you make smarter business decisions, and potentially lower financial stress. You might already be well beyond the break-even point and not even know it.
How to do a break-even analysis
There are 3 steps to calculating your break-even point.
Step 1: Gather your data
You need to know all the costs of doing business.
- Fixed costs - These are costs that are constant such as rent, bank fees or insurance fees, and wages for salaried staff.
- Variable costs - These fluctuate monthly, even weekly. These include things like fuel costs, catering costs for meetings, wages for contract staff, and utilities costs.
- The average price of your product or service - This item can change if you’re not ready to commit. You may offer discounts for some customers, so understand this is the average price for your products.
DON'T FORGET ANYTHING.
One of the pitfalls of this process is when you forget some expenses. Costs that pop up only once a year - web hosting, for example - you might not include because it's eight or nine months away.
Remember, this process can only be as good as the data you feed it.
Step 2: Add your data
Put your data points into the formula:
Break-even point = Fixed Costs / (Average Price - Variable Costs)
Divide your fixed costs by the average price of your products, less the variable costs. This will tell you how many units of product or service you need to sell to hit the break-even point.
For example, you produce fidget spinners. The fixed costs of producing these fidget spinners, per year, is $40,000. Your variable costs, per spinner, is $3 for materials, $5 for labour, $2 for overheads - $10 total. And you want to sell these fidget spinners for $15 each.
BEP = 40,000 / (15-10) = 8,000 units
Step 3: Adjust your data
Make changes to your data and see what happens. Change the price you sell your products and services at and move the BEP. Increase the supply chain costs, and see how you can adapt.
Your results may change as you often forget some costs the first time you try a break-even analysis.
Always update your formula when data changes. If you find a better and cheaper supplier, you can move your BEAP and suddenly have more profit.
How do I lower my break-even point?
Lowering your break-even point means you’ll hit profit earlier, which is a good thing for your business. There are four main ways you can do this.
- Decrease the number of fixed costs - Fixed costs are easier to measure and account for. By removing some fixed costs, you can easily calculate the change in the BEP. Can you change insurance providers or web hosts? Saving some money here and there can have a big impact.
- Reduce the variable cost - Harder to account for, but they can be adjusted. Switching a casual employee to part-time can reduce the hourly rate and give more certainty to the formula. See if there are certain teams or areas in your business that are spending money on things they really don’t need and help them learn how to tighten down on budget spend for maximum impact.
- Enhance the sales mix - A sales mix is having different items for sale at different price points - for example, bronze, silver and gold level products, where bronze costs the least and gold the most. If you can change the sales mix to sell more gold units, and fewer bronze units, you may have the same number of units sold, but the sales revenue will increase.
- Increase sales price without decreasing the number of units sold - Often, if you raise the price on an item, fewer items are sold. For some products and services, this is not the case - think petrol. While prices may go up, and people complain, they still buy petrol to fuel their lives. If you can raise the prices of your products and services marginally without affecting sales, you can again bring the BEP closer.
Hire a business coach
How can hiring a business coach help you hit your break-even point? Our business coaches have worked with a lot of people in business and helped them succeed. They’ve worked to help teach many business owners how to bring the BEP closer, allowing them to thrive and grow their dream business.
Our business coaches can help you too by identifying your fixed and variable costs, give tips on how to reduce them, and help you improve your sales mix by adding things like marketing diversification.
We have business coaches all over Australia waiting to help you hit the ground running and break-even in record time.
Have more questions?
Did you want to know more about breaking even and doing it rapidly? See how you can book in a free discovery call with one of our Entrepreneur Development Managers to see how our team of business coaches can help empower you to build the business of your dreams.
Join the movement.
Your Entourage journey starts here. Join Australia's largest community of over 500,000 business owners and entrepreneurs, and receive instant access to exclusive content and updates delivered straight to your inbox.