When your business reaches the break-even point, it means your income matches your expenses, with no profit or loss. This point is crucial because it helps you understand when your revenues can cover all your costs. Knowing your break-even point allows for smarter business decisions and better management. It can take a while—sometimes months or even years—for a small business to hit this mark and stop losing money. But knowing when this might happen can make attracting investors, securing loans, and running your business smoother.
Before you start your business, figuring out the break-even point is helpful. It tells you the minimum sales you need to start making profits and may also uncover other factors that can affect your profit. This analysis can help you determine optimal pricing, reasonable sales targets, hidden costs, whether the business can be profitable, the feasibility of launching new products or services, and how quickly you can bounce back from setbacks.
The break-even point is a critical part of your business plan, indicating to potential investors and lenders that your business has the potential to make money.
To understand break-even in accounting, you need to grasp a few terms:
- Fixed costs: Expenses that don’t change, like rent and salaries.
- Variable costs: Expenses that change with production, like materials and shipping.
- Semi-variable costs: Expenses that are partly fixed and partly variable, like electricity.
- Contribution margin: The difference between the selling price per unit and the variable cost per unit, expressed as a percentage of the selling price. This helps indicate how much each sale contributes to covering fixed costs.
- Unit: A single item or service you’re selling, like one chair or one hour of service.
Once you understand these terms, you can start calculating the break-even point using some accounting equations. To find your break-even point, you’ll need your total fixed costs, the unit sales price, the variable cost per unit, and your sales projections in units.
Here’s the basic math:
- Break-even point (in units) = fixed costs / (unit sales price – variable unit cost).
- Break-even point (in dollars) = fixed costs / contribution margin.
For example, if you’re selling picture frames with fixed costs of $5,000 per month, variable costs of $1 per frame, and a selling price of $10 per frame, you need to sell about 556 frames a month to break even: $5,000 / ($10 – $1). Alternatively, in dollars, you would need $5,556 in sales: $5,000 / [($10 – $1) / $10].
Keep in mind that your calculations are based on estimates since start-ups lack historical data. It’s wise to add around 10%-12% to your predicted costs to cover unexpected expenses.
The factors affecting your break-even point, like price and costs, can change over time. You might experiment to see how varying these can impact your profitability, especially during tough times like recessions. If sales drop, hitting your break-even might be tough, and you could struggle to pay suppliers. Adjusting things like variable costs by negotiating with suppliers could help. If you reduce variable costs from $1 to 75 cents, your break-even point changes to 540 frames. If you’re able to lower fixed costs temporarily, like cutting salaries, the break-even point might drop further to 500 frames.
By running break-even analysis and considering different scenarios, you can prepare better. For instance, if you need to sell 500 frames a month to break even, you must decide if this is feasible. If it seems achievable, you might just have a solid business opportunity. If it’s difficult but possible, look for cost reductions or seek initial funding to help during tough times. But if it seems unachievable, reconsider if the business idea is viable.
Remember, you can’t fully control customer demand. If there isn’t enough interest in your product or if demand drops, breaking even might become impossible.
