As a business owner, it goes without saying that your ultimate goal is to make a profit. But, before you do that, you have to reach a break-even point (BEP). This is the point at which revenue will match your expenses.
If you can figure out how to perform a break even analysis, you can determine whether or not your company has reached its BEP. Even if you haven’t reached that point yet, performing a break even analysis can help you determine when you will reach that point, so that you have something tangible to work toward.
Let’s take a look at the various methods that many companies have used to see how close they were to their own BEPs and you will learn how to perform a break even analysis.
Your Company’s Costs
When it comes to trying to determine what your company’s BEP will be, there are several factors that you need to consider. Among them are:
- Your Fixed Costs – These are the costs associated with your company that never change: things like the rent on your office space, your insurance, utilities and the like.
- Your Variable Costs – These are expenses that can change from month to month. Things like shipping payments can be considered variable costs that your company has to undertake. If you perform a service, the quantity of how many items you need to buy in order to perform that service can also change from month to month.
- Your Prices – How much are you going to charge a single customer for a unit of what your provide? Having a concrete answer for this is essential to determining your company’s BEP.
- Your Revenue After Each Sale – After performing the service, you have to look at how much money is left (from the customer’s payment) once you’ve recovered the costs directly related to performing the service. This amount is your average gross profit.
Each of these costs goes in to figuring out how to perform a break even analysis. Once you have these costs sorted out, you’ll know exactly how much you need to sell in order to cover all of the costs associated with your business.
In order to figure out exactly what your BEP is, you need to divide your company’s fixed costs by the contribution margin of your of your product.
The contribution margin is what you get when you subtract the variable costs related to a unit of whatever you sell from the sale price of that unit.
Say you run a pizza shop and you want to figure out the margin on a large cheese pizza. Let:
Margin (M) = ?
Price (P) = $12
Ingredients (I) = $3
Wage (W) for the employee who makes the pizza = $7
The formula for the contribution margin would be P – (I + W) = M or 12 – (3 + 7) = 2
This means that you make two dollars off of every twelve dollar pizza that you sell.
From there, you take the fixed costs that your business has over a certain period and divide them by the two dollars that you make on every pizza. This would tell you how many pizzas you need to sell in order to break even over that given period.
The complexity of the formula for how to perform a break even analysis depends on the variety of your offerings. In the above example, you would need to factor in the different kinds of pizzas you sell, as well as other food items, but the general idea is always the same.
Cutting Your Company’s Costs
If, after you figure out how to perform a break even analysis, you BEP is higher than you’d like it to be, you can look at your costs and figure out where you can retool certain aspects of your business in order to lower the BEP.
This process can range from raising the prices on your products and services to using the most cost effective supplies or finding another office space where your rent isn’t as high. By figuring out how to perform a break even analysis, you can take variables and put them in place of the actual numbers to try and find the best solution for running your business, so that you can see a healthy profit in no time.
Remember, running a business successfully does not need to be complicated. Keep it simple!
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Manny Skevofilax is a consultant and speaker that assists his clients with successfully navigating the challenges of growing their businesses profitably. Since 2003, Manny helps businesses to enhance their financial results by using his experience in strategic planning, financial statement analysis, operations, 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.