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When starting your business one of the biggest questions to ask yourself is when you will break even. About 20% of new small businesses fail within the first year because of financial difficulties. If you find out your break-even point formula ahead of time and check it frequently, you can help prevent failure.
What Is the Breakeven Point?
The breakeven point of a business is when the revenue equals the costs, meaning at this point there is no profit or loss. It is important to know what your breakeven point is to help you decide prices, set sales budgets, and prepare a business plan. By understanding where your breakeven point is, you will know:
- How profitable your current product line is
- How many units you need to sell before you make any profit
- How reducing the price or volume of sales will impact your profit
- How much you need to increase your price or volume of sales to make up for increased fixed costs
How to Calculate the Breakeven Point
There are a few basic formulas for determining a business’s break-even point. The calculation is based on the number of units of product sold and the other calculation is based on points in sales dollars.
The following calculation is to calculate breakeven based on units:
Break-Even Point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)
The following calculation is to calculate breakeven based on sales dollars:
Break-Even Point (sales dollars) = Fixed Costs ÷ Contribution Margin
Contribution Margin = Price of Product – Variable Costs
Fixed costs are expenses that keep your business operating on a daily basis. These include rent or mortgage payments, utilities for your building, insurance, employee salaries, office equipment, and more.
To determine your variable unit costs, you need to consider everything that went into the production process such as testing and research. If your business does not have products, your variable costs include storage costs, shipping, packaging, and other fees that you incur when getting your products.
Why It Is Crucial to Calculate Your Breakeven Point
There are quite a few reasons as to why it is important that you determine your breakeven point early on, even if your business is far from being profitable. Knowing the amount of money, you need to make to cover operational costs will help you create a detailed business plan. It can also help determine which kind of additional financing is best for your business. By calculating your breakeven point, it can help you plan for new products and help you price them to cover their costs.
Limitations of the Breakeven Analysis
Once you have calculated your breakeven point, it is important to understand what the results are telling you. The calculation should be feasible and if not then you will need to adjust your pricing, take a look at your costs, and see where you need to make some cuts.
If the number of units you need to sell is too high making it unrealistic or unattainable, there are a few ways you can lower your breakeven point. You can lower your fixed costs, raise your prices, or lower your variable costs. Lowering your variable costs is the most difficult option but it is worth trying to lower by negotiation with suppliers and vendors.
The Bottom Line
Calculating a breakeven point on your business is an important tool for making good business decisions. It can help you determine whether you have the best pricing strategy to meet your business goals. It is not the only way you can determine the profitability of your business, but it can help give you insight and understand your business decisions you face every day.
