Analysis break-even point is a tool used to determine when a company will be able to cover all its expenses and start generating profits. Knowing startup costs is extremely important for the startup business, which gives you the information you need to generate enough sales revenue to pay for ongoing expenses related to running your business.
A new business owner should understand that $ 5,000 of product sales will not cover $ 5,000 in monthly overhead. The cost of selling $ 5,000 in retail goods could easily be $ 3,000 at wholesale price, so the $ 5,000 in sales revenue only provides $ 2,000 in gross profit available for overhead costs. The breakeven point is reached when revenues equal all business costs.
To calculate your breakeven point, you will need to identify your fixed and variable costs. Fixed costs are expenses that do not vary with sales volume, such as rent or administrative salaries. These costs must be paid independently of sales and are often called overhead costs. Variable costs vary directly with sales volume, such as the costs of purchasing inventory, shipping, or manufacturing a product.
The formula for determining your breakeven point requires no more than simple arithmetic.
Will your business make money?
Before preparing a business plan, you need to find out if your business will break even. Find out where you break even. How many sales until this event occurs?
How can you tell if your business idea will be profitable? The honest answer is that you can’t. But this uncertainty shouldn’t stop you from investigating the financial strength of your idea. Preparing what is known as a balance analysis, as well as various other financial projections, can help you determine whether or not your business will be successful.
What an equilibrium analysis tells you
Your equilibrium analysis shows you how much income you will need to generate to cover your expenses before you make a penny of profit. If you can break even, that is, if you can easily generate more than the amount of sales income you will need to cover your expenses, then your business has a good chance of making money.
Many seasoned entrepreneurs use an equilibrium analysis or forecast as a primary screening tool for new business ventures. They won’t even write a complete business plan unless their equilibrium forecast shows that their projected sales revenue far exceeds the costs of doing business.
How to prepare a balance analysis
To perform a balance analysis, you will need to make educated guesses about your expenses and income. Although you don’t have a crystal ball, you should do some serious research, including an analysis of your market, to determine your projected sales volume and anticipated expenses. The best thing to do is invest in a DIY business plan product to learn how to make reasonable estimates of income and costs.
You will need to make the following estimates and calculations when preparing your equilibrium analysis:
Fixed costs. Fixed costs (sometimes called “overhead”) don’t vary much from month to month. They include rent, insurance, utilities, and other fixed expenses. It is also a good idea to invest a little more, say 10%, in your balance analysis to cover miscellaneous expenses that you cannot predict.
Sales revenue. This is the total dollars of sales activity that you contribute to your business each month or year. To perform a valid break-even analysis, you must base your forecast on how much business you actually expect, not how much you need to make a good profit.
Average gross profit for each sale. Average gross profit is the money left over from every dollar of sales after paying the direct costs of a sale. (Direct costs are what you pay to provide your product or service.) For example, if Amy pays an average of $ 100 for lingerie items that she sells for an average of $ 300, her average gross profit is $ 200.
Average gross profit percentage. This percentage tells you how much of every dollar of sales revenue is gross profit. To calculate your average gross profit percentage, divide the average gross profit figure by the average sales price. For example, if Amy makes an average gross profit of $ 200 on lingerie that sells for an average of $ 300, her gross profit percentage is 66.7% ($ 200 divided by $ 300).
Calculate your breakeven point
Once you’ve calculated the numbers above, it’s easy to determine your breakeven point. Simply divide your estimated annual fixed costs by your gross profit percentage to determine the amount of sales revenue you’ll need to generate just to cover expenses. For example, if Amy has fixed costs of $ 6,000 per month and her expected profit margin is 66.7%, her breakeven point is $ 9,000 in sales revenue per month ($ 6,000 divided by .667). In other words, Amy must earn $ 9,000 every month just to pay her fixed costs and her direct (product) costs. (This number does not include any earnings, not even a salary for Amy.)
Don’t give up on an equilibrium analysis
Although creating a balance forecast may seem complicated, it is up to you to prepare one as one of the first steps in your business planning process. As you can see, a realistically prepared equilibrium forecast will tell you whether your idea is a sure winner, a sure loser, or like most ideas, needs modification to make it work.
If you can’t match
If your breakeven point is higher than your expected income, you will need to decide whether certain aspects of your plan can be changed to create an achievable breakeven point. For example, maybe you can:
Find a less expensive source of supplies
- Dispense with an employee
- Save your rent by working from home, or
- Sell your product or service at a higher price.
If you play with the numbers and your balancing sales income still seems like an unreachable number, you may need to scrap your business idea. If that’s the case, take heart from the fact that you found out before investing your money (or someone else’s) in the idea.
Additional financial analysis
If your equilibrium forecast shows that you will be making more income than you need, you may consider yourself lucky. But you still need to find out how much profit your business will generate and whether you will have enough cash on hand to pay your bills when they are due. In short, an equilibrium forecast is an excellent evaluation tool, but you need a more thorough analysis before you start investing real money in your company.
The following are additional financial projections that should also be part of your business plan, to complete the financial picture of your company.
A profit and loss forecast. This is a month-to-month projection of your company’s net operating profit.
A cash flow projection. This shows you how much actual cash you will have, month by month, to cover your expenses.
An estimate of start-up costs. This is the total of all the expenses you will incur before you open your business.
Preparing an equilibrium forecast will help you decide whether a business plan for your idea is worth making, but it should never replace a full profit and loss forecast and cash flow projection.
It all starts with a dream, then you add a touch of reality to it and who knows where it goes!