How to Calculate a Break-Even Point
There are many things you’ll have to consider when your business launches, but where do you start? As a small business owner, the first thing you’ll want to think about is when your business will start making money, aka “break-even”. Breaking even is when your revenue is equal to your costs. Understanding your break-even point allows you to have better insight on your pricing model and costs.
As your business continues to grow, you’ll need to think about calculating different break-even points to make sure your business makes its money in the long run. In this article, we’ll discuss how to calculate your break-even point, what information you need to calculate it, and the four steps you can take to start.
In its simplest form, the break-even formula is:
Whether you’ve heard these terms before, used them for calculations, or have never seen them, they’re necessary terms to know for any kind of business. Here are more in-depth definitions as well as common examples:
Fixed Costs
Fixed costs are costs that always remain the same in your business model, no matter the quantity you produce. They’re paid by the company and are typically seperate from specific business operations. Examples of common fixed costs include rent payments, taxes, or employee salaries.
Variable Costs
Variable costs are costs that change when the quantity of services or goods increases. Some examples of common variable costs include the raw materials needed to produce your product, direct labor, commissions, and packaging costs.
Sales Price
Sales prices are the price you choose to sell your product or service at. Depending on your business, the margin between your sales price and variable costs can be different. The break-even analysis will also provide you with a better idea of whether or not you have chosen the best sales price for your business plan.
Break-Even Quantity
Break-even quantity is the quantity of goods or services that you’ll need to sell in order to break even. After calculating your fixed costs, variable costs, and determining the sales price, you’ll get this number. If the number seems unreasonably high or low, you may need to reconsider your sales price.
Now that you have a better understanding of the different factors that go into creating a break-even analysis, you can start calculating. Let’s say you start a bakery and are selling cakes, you can follow these four easy steps:
Calculate and add all of your fixed costs. This can include the cost of your store’s rent, commercial equipment, insurance, taxes, and salaries.
Calculate and add all of your variable costs. This can include the cost of flour, sugar, cake packaging, hourly wages, and shipping costs.
Determine your sales price. After doing your research around competitors prices and costs, you can determine the price at which you want to sell your cakes.
Make adjustments as necessary. After making all of your calculations, you see that you need to sell 40 cakes a day in order to break even, but you only have the capability to make 30 a day. In this case you may need to adjust your prices or find ways to decrease your costs. In any case, you’ll need to think of how you can realistically sell the amount of cakes that are required to break even, if not more.
Creating a simple break-even analysis is a quick and easy way to plan a future product launch, setting goals for your business, determining if your costs are sustainable, and pricing your products. That in mind, there’s no way to 100% guarantee your projections, so make sure to test several versions of your sales price to set your business up for success.
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