When starting a business, it’s recommended to plan for 12 to 15 months of cash flow to keep your business afloat as it gains traction. Part of that planning will consist of knowing the amount of business you need to avoid being in the red and cover your overhead costs.
Even if you’ve been running your business for a few years, knowing when you’ll break even at various sales volumes for different products or services can help you better prepare for unprecedented situations like a pandemic or natural disaster. It will also come in handy when presenting your business to potential investors or business partners.
For a step-by-step guide on how to calculate your break-even point (BEP), keep reading.
The break-even point is the point in which your company’s costs equal its revenue. When this happens, your business is neither losing nor gaining money. If your revenue is under your costs, you’re operating at a loss. If your revenue is higher than your costs, you’re making a profit.
There are two common ways to calculate your break-even point—in units or sales dollars. But before we go over those formulas, here’s a breakdown of the different components you’ll need to know before you start your analysis.
Single product or service sold.
Although you can estimate your break-even point by adding up the monthly, quarterly, or yearly totals of fixed costs, variable costs, and sales prices, you can also calculate the BEP for each product or service sold. This is usually recommended if the cost of your products or services varies significantly or the services you provide vary by season.
How much in sales dollars you will charge your customers for the product or service sold. Be sure to enter the sales price for the product or service you’re calculating your BEP for or using an average sales price for your products and services.
Costs that do not change over a period of time despite an increase or decrease in sales. These are usually recurring weekly, monthly, quarterly, or yearly costs.
This can include:
Costs that change over a period of time depending on the volume of sales.
This can include:
Contribution margin is the difference between the price of a product or service and the cost to make that product or perform the service.
Formula:
Divide your monthly, quarterly, or yearly fixed costs by the difference between your sales price per unit and your variable cost per unit. Again, if you’re calculating each break-even point for your different products or services, be sure to enter the fixed costs, variable costs, and sales price for that particular product or service.
Formula:
Sally owns a beauty salon and she’s trying to determine the monthly volume of haircuts she’ll need to make to break even. A haircut at Sally’s is priced at $50 with a $5 variable cost per client. Her monthly fixed costs are $15,000.
Here’s how she calculated her BEP:
Divide your monthly, quarterly, or yearly fixed costs by the contribution margin. Again, your contribution margin is obtained by subtracting your variable cost per unit from the sales price per unit and dividing that total by the sales price per unit.
Formula:
Joe owns a landscaping business and he’s trying to figure out how much money he needs to make to break even during his first quarter. Joe’s average lawn care visit is priced at $60 with a variable cost of $10 per visit. His quarterly fixed costs are $24,000.
He first calculated his contribution margin:
He then calculated his BEP in sales:
Again, a break-even analysis is a helpful tool to use when preparing for unexpected circumstances or when presenting your business plan to a potential investor.
However, there are many more benefits to knowing your BEP. Here are a few:
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