Business Development - Break Even Analysis (Part 1)
Every business owner should be aware of their break even point.
This is the point where sales exactly cover costs so that no profit is generated, but no loss is incurred.
As a management tool the break even analysis can be applied to much broader questions and can help you answer some of the following questions, as an example:
- What additional sales will I need to cover the rent increase my landlord is proposing?
- If I (the business owner) would like to take a further ‘profit’ of $20,000 each year out of the business what sales do I need to achieve?
- If I raise my prices, how much can sales drop before my profits are affected?
Steps to calculate Break-Even
Step 1 - Classify all your expenses on your profit & loss as either fixed or variable:
- Fixed costs are those expenses that remain constant over a reasonable range of sales, or do not vary with sales volume. Examples may be rent, wages, insurance etc.
Variable costs are those expenses that vary directly to sales. Examples may be, materials, stock, commissions and direct wages.
Step 2 - Determine the variable expense percentage using the following formula:
Step 3 - Determine the contribution margin using the following formula:
Step 4 - Calculate the break even in dollars using the following formula:
By using the above formulas in your business you should now know what level of sales are required for your business to break even. Our next article will put all the above information into a simple practical example, by showing you how your break even can be used in your business to help you make educated decisions.
If you would like to discuss how we can help improve your business please contact Shaun Otto for a no-obligation consultation.