Do you know all about the break even analysis formula and how it helps your business stay on track?
If not, then it’s something that you may want to learn, because it will aid you in your financial decision-making for your company. This calculation is one of many tools that you can use to help your business remain successful from a financial perspective.
Let’s take a look at what goes into a break even analysis formula, so that you can get a clear understanding idea of how it impacts your business operations.
What Is Breaking Even?
In the simplest terms, “breaking even” is the point you reach in your business operations where the revenue you bring in matches the money you spend to keep your business going.
It isn’t profit, but it’s a huge step toward reaching the always sought-after profit. So what can you do to reach the point where your business breaks even?
Let’s look at two key areas of your company’s operations and take this analysis piece by piece.
What You Spend
“You have to spend money to make money”
You’ve undoubtedly heard that saying at some point in your life, maybe before you even set out to be a business owner.
And it’s 100% true.
Companies take on all kinds of forms, shapes, and sizes, and operate across a wide variety of industries, but one thing they all have in common is that they require some kind of overhead expense that has to be paid to keep the doors open.
It could be something like a monthly lease on an office space, the supplies used to get the job done, or money spent on gas getting from job site to job site.
Regardless of what the item is, “overhead” is an expenditure that goes toward furthering your enterprise and, as such, is classified as a cost.
Costs typically fall into one of two categories: fixed costs, and variable costs.
- A fixed cost is a cost that stays the same from month to month and is easier to budget as a result.Think about items like your bills that cycle every month; power, rent, insurance, payroll, and so on, to get an idea of what your fixed costs are.You can also think of these in the context of your break even analysis formula as costs that aren’t dependent by what your company produces. Whether your revenue is up or down during a given month, these costs do not change.
- Variable costs, on the other hand, fluctuate with your company’s activity. If you take on more jobs than normal, you will need more supplies and man-hours to handle the additional work.If a large order that you don’t typically handle comes in, you will need to order more supplies and perhaps pay overtime wages for longer periods of time in order to create greater quantities of product.These are just two examples of variable cost that many businesses face, but factoring in this aspect of business finance is essential to creating an accurate break even analysis.
What You Bring In
On the other side of the break even analysis formula, you want to take a close look at the money you bring in through the sale of your goods or services.
Your company relies on its customers to stay in business, so you want to give them some level of incentive to do business with you rather than one of your competitors.
Weigh pricing carefully enough that your customers receive value for their money, while the endeavor also proves to be worthwhile on your end.
After you make a sale of a single unit, you’ll ideally have made enough to cover production, plus some extra money beyond that.
This gross profit is the next critical part of your break even analysis formula and the number that will help you figure out what your company needs to make in order to cover all of the cost associated with the business.
How It All Works Together
Figuring out your company’s break even point is a much simpler calculation than you might think, as it breaks down to:
Fixed Costs / (Selling Price – Variable Costs)
The number that you get from this equation will let you know how much you need to sell to reach a point where you make back more than what you’ve put in. Each additional unit sold after this point is called contribution margin, which tells you what each additional unit sold contributes toward profit.
Shaping Your Financial Future
At the end of the day, being able to calculate what you need to sell in order to be prosperous is a necessity to a growing company like yours. Try to ensure that the information you extract from your use of a break even analysis formula has enough detail that it gives you insight into where changes can be made if needed.
By framing this information within the larger sphere of your company’s financial statement, you can have a very valuable, comprehensive tool that will help move things forward for years to come.
Remember, running a business successfully does not need to be complicated. Keep it simple!
For more information on business analysis, business planning, and ways to grow your small business profitably, please check out our website www.portalcfo.com. Follow us on Twitter @portalcfo
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Manny Skevofilax is a consultant and speaker that helps his clients successfully navigate the challenges of growing their businesses profitably. Since 2003, Manny helps businesses enhance their results by using his experience in strategic planning, financial statement analysis, operations, organizational development, and team-building. His consulting firm, PORTAL CFO Consulting, Inc., has attracted clients from diverse industries in the United States and abroad.
Manny can be reached at 410-808-3441 or via email at email@example.com.