How to Calculate Your Business Break-even Point!
Calculating a business break-even point is not difficult. However, there are a few things you need to know in order to make it as accurate as possible.
As a review, your monthly break-even point is reached when your gross sales revenue equals your total expenses; it is the point that your business begins to make a profit. (Please refer to my previous article for an overview of this principle.)
Get Your Profit and Loss Statement
To begin, you need a copy of your Profit and Loss Financial Statement. If you can, get a printout that shows year-to-date information and the percent of sales for each line item. Divide the year-to-date total for each item by the number of months to get the average monthly expense. Averaging multiple months will minimize the effect of any unusual expenses in a single month.
Don't forget to include the monthly portion of line items paid on a quarterly or annual basis such as payroll taxes or insurance. For example, if your annual insurance charge is $9,000, use 1/12 of that, or $750 as part of your monthly budget.
Upon looking at each line item, you will first decide with costs are fixed, which are variable, and which are a mixture of both. Let's discuss each.
- Fixed Costs - These expenses are dollars paid or accrued each month, even if you don't make a single sale. They include such things as rent, insurance, utilities, equipment leases, contracts, accounting fees, and so forth. Fixed costs are sometimes referred to as overhead or administrative costs.
- Variable Costs - These expenses are directly related to the products or service you deliver. They include line items such as materials, supplies, labor, and shipping expenses. Variable costs are generally referred to as cost of goods or cost of sales, and are best represented as a percent of sales. For example, materials and labor might be 50% of the sale price.
- Mixed or Semi-Variable Costs - These costs are part fixed and part variable. If they are not broken out separately on your Profit and Loss Statement, you will have to estimate them for your break-even analysis.
For example, some of your wages may be administrative (fixed), while other wages are related to the products produced or services performed (variable).
Your utilities, such as lights and heating are fixed; however, power to run equipment for producing a product is variable.
If you have a marketing budget that is a percent of sales, this would also be a variable cost—the more you sell, the more you spend on advertising. If you have a minimum monthly advertising expenditure or set media contracts such as radio, television or newspaper, these costs are fixed; you pay them every month, even if they don't generate any sales.
In a final, let's say you hire a new sales person and want to use a break-even analysis to discover how much more you need to sell in order to cover his or her cost. If the sales person is paid a salary, the cost is fixed; if paid on a commission, the cost is variable. Paying a salary plus commission or bonus would be a mixed cost.
I think you get the idea. Keep in mind that costs change and expenses tend to creep up. Recheck the number periodically. Beware: Break-even points are dramatically affected by hiring new people without a corresponding sales increase.
Compute Your Break-even Point
The formula for computing your business break-even point is described below. Don't worry if it doesn't quite make sense. I am providing a spreadsheet tool so you can just plug in the numbers. Remember to use numbers for the average month.
Lower Your Break-even Point
As mentioned in my previous article, there are four ways to reach your break-even point earlier in the month, and begin making a profit sooner.
- Lower your overhead costs (fixed costs) - Keep fixed costs to a minimum and resist the temptation to increase them, unless absolutely necessary. It's very hard to go back if sales drop. However, don't cut too deeply, especially if there is a negative effect on customers or employees
- Lower the cost of each product or service sold (variable costs) - By lowering direct costs, your gross margin will increase. Be diligent about purchasing material at the most favorable price, controlling inventory, or improving the productivity of your workforce.
- Increase your pricing (and gross margin) - Most business owners are reluctant to raise prices because they think that sales will decline. More often than not, that doesn't happen, unless you are in a very price-sensitive market. Raising prices only a few percent will have a significant effect. There is a delicate balance between sales volume and pricing margin so be cautious about changes, and test if you can.
- Increase your sales - The toughest job of most small business owners is to increase sales. A business owner nowadays must be an outstanding marketer, or able to hire one. Never stop trying to improve marketing and sales strategies. Keep the pipeline full. Push every order you possibly can out the door by the end of the month, and then do it again next month. You make all your profit on those last few orders. And remember, a bad month can wipe out the profit of several good months.
As a Systems Thinker, your first thought is, "What systems do I need to improve to hit my financial break-even point sooner. How can I make my administrative systems—hiring, accounting, computer support, custodial—less costly? Can I improve my purchasing system to buy materials or supplies at a lower cost? Can I reduce labor costs without affecting customer service? Could I change my pricing system or terms to squeeze out a little more margin? Can I improve my lead generation or sales conversion systems to close more sales?
You might be surprised by how many opportunities there are to cut overhead costs or create more margin in your product or service. Those opportunities are just waiting to be discovered as you work on your business in The Zone.
Motivate Your Employees
By the way, if you work on a tight margin, it can be a good idea to let employees know your break-even point. This gives them a clear picture of expenses and what it actually takes to run the business. It also motivates that little extra oomph at the end of the month to get orders out the door.
Many businesses have gone under because owners didn't know this single number—the sales break-even point. DON'T LET THAT HAPPEN TO YOU!
Do You Know Your Sales Break-even Point?
Access a Spreadsheet for Doing a Break-Even Analysis
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