Why does break-even analysis matter? The break-even point helps business owners determine when they will be profitable and assists them with pricing their products. Improving the bottom line is an ongoing challenge to business owners. Break-even analysis is a great tool to see the impact of changes in prices or expense items on your profitability.
I talk to business owners regularly who say they want to be able to give back in some way. The conversation often starts with “I plan on donating (some) % of every sale to (insert important cause here)”. I love that they want to make a difference in the world through their business. But here is where I have to issue words of caution. As a business owner, you owe it to yourself, your business, investors, employees, and most importantly, the customers who count on having access to your products and services, to be profitable. So – profit first, philanthropy second. If your business isn’t around it isn’t much help to anyone.
Break-even Analysis: The Formula
In order to determine your break-even point, you will need to know your fixed costs, your variable cost per unit and your price per unit. The formula is:
Fixed costs for the period (usually monthly) / (sale price per unit – variable cost per unit)
Break-even Analysis: Hamburger Restaurant Example
|FIXED COSTS PER MONTH||VARIABLE COSTS (COGS) PER UNIT|
|Utilities||$ 450||Ground Beef||$1.00|
|Total||$5,450||Total||$2.05 per hamburger|
Break-even = Fixed Expenses per Month / (Price per unit – COGS per unit)
Break-even = $5,450 / ($7.50 – $2.05) = $5,450/$5.45 = 1,000 hamburgers
Based on the total variable costs per hamburger, we know that each hamburger must be priced at a minimum of $2.05
If the price is set at $7.50 per hamburger, we will have $5.45 left to contribute to fixed expenses and profit.
Just to break even though, we need to sell 1,000 hamburgers per month or 34 per day. Every hamburger sold over this contributes to profit.
Using Break-Even Analysis to Test Changes to Profitability
You can use break-even analysis to test the impact of any changes to the financial structure of your business. This includes changes to price, variable and fixed costs. Simply substitute the new numbers into the equation. It is also an excellent tool to evaluate the impact of your owner’s draw on break-even. Add the amount you wish to take out of your business every month as a draw to your fixed monthly expenses then calculate how many more units you will have to sell to break-even. In the example above, adding an owner’s draw of $1,500 per month would increase the number of hamburger sales needed to break-even to 1,276 per month or 43 per day.
Break-even = ($5,450 + $1,500) / ($7.50 – $2.05) = $6,950/$5.45 = 1,275.23 rounded up to 1,276 hamburgers
Check out this break-even calculator to test your model.
Once you have completed your break-even calculation, it is important to understand what the results are telling you. If your calculation tells you that you need to sell 500 units to break-even, your next step is to determine whether this is feasible. Looking back on your market research you should be able to tell if you will be able to sell 500 units within a reasonable time period given the financial situation of your business. This is where you need to decide if you have the right product at the right time serving the right market. It is time to either pivot or proceed.
If you really want to get your business on a clear path to success, check out ProfitRx, our business development program.