Determining Your Small Business Break Even Point
One of the biggest missteps we see as bookkeeping experts is new companies with lofty goals that have never taken the time to understand exactly where their profitability will begin in a new venture. Examples abound, but taking the time to understand where the break even point lies in your new business – or even your existing one – is a critical step in growing your company. Not doing so can lead to financial challenges and that’s why we recommend every entrepreneur perform a break even analysis of any business – new or established – that they operate. Why? It forces you to understand exactly what the volume of a company or a department needs to be.
So What is the Break Even Formula?
The Break Even Formula is simple:
That’s it! There’s virtually no way that anyone can get lost in the equation, but plenty of business owners do. The key things to remember are understanding every variable cost that goes into producing your product. Remember, it may only be $3 worth of material, but in many cases, businesses forget to account for the labor costs to produce that unit.
Sales Per Unit
This is the actual sales price of the products or services your company is selling. Let’s say, a phone case for $8. Many times, as simple as the break even formula is, owners fail to plug in the right numbers. Remember, the key to the break even formula is that you don’t use it one time, but over and over again as your business grows, takes on new products, and expands into new areas.
Fixed Monthly Expenses
Now that we’ve established a preliminary cashflow into the business, we need to understand how it will flow out of the business. Any business will have these and they will remain largely static month after month. These could be rent, software, salaries for the principals, or a variety of other things, but they will be stable month after month. The good news with fixed costs is that they can be budgeted for month after month and the actual dollar figure will be stable for projection purposes.
Variable costs are the real challenge in any break even formula. The simple fact is they are difficult to project and can impact the profit you are using in your analysis. They may change due to a variety of reasons, but some examples are:
• postage and shipping for customer purchases
• product delivery costs
• raw materials
• inventory of products to be sold
• employee wages for producing products
• utilities used in production
• sales commissions
As you can see, these can be difficult to differentiate and all impact the figures you are using in your analysis.
So How Much Does Your Business Have To Sell To Break Even?
That is always a critical number that you, as an owner, and your stakeholders or even creditors will want to know. The key is to always remember: the break even point is the financial point where a business is able to pay all the costs associated with operations from the profits earned by the company. Our advice? Know what you are looking at and if you are unsure how to prepare or read a break even formula, then ask us to review – or even prepare – such a document for you.
Time and Financing – two critical values for understanding break even points.
When you’ve taken the time to understand your company’s break even point, you gain valuable insight into tracking future profitability. At the same time, in the case of a new company, owners can track, from the day the doors open until the company has reached the break even point, how long the company will be operating in the red.
This also allows an understanding of how much money a company has in reserve to spend before it MUST turn a profit. If you know that you have to spend $3,500 per month and you have cash reserves of $50,000, then you know that you have slightly over a year to become profitable. Take this advice – take the time long before you open the doors to understand what your company can actually make in profit – but be realistic in your understandings of how long it will take to do so and what shortcomings you’ll need to make up in case of unforeseen costs changes. Even better? Make an analysis as important as this with someone who understands how it is done and can provide impartial, practical advice and feedback.
By: Chris Groote
All rigths reserved to: Bookkeepwithus.com