What is a Break-Even Analysis?

what is a break-even analysis

Have you ever looked at your company’s sales and financial reports and wondered, “When are we going to break even?” If so, you are not alone. Countless small business owners are often perplexed as to why the combination of their fixed costs and variable costs is higher than their sales revenue. This scenario is even more confusing to business owners whose companies are generating robust sales and surpassing monthly and quarterly forecasts, but are not seeing any profits. Over time, this can cause a small business to fail.

Determining your break-even point for the products you sell can help you pinpoint problems that you might not be aware of, and that are hurting your bottom line. For example, your prices might be too low based on the costs and expenses that pertain to your products. To find out what your break-even point is, you will need to conduct a break-even analysis, an overview of which is featured in this Balboa Capital blog article.

Calculating a break-even point.

Your break-even point is the intersection at which all of your fixed and variable costs meet – and match in terms of dollar amount – to your sales revenues. To calculate your break-even point, you need to first add up your fixed costs. The next step is to divide this number by the sales price per unit minus the variable costs per unit.

To explain this in more detail, here is a hypothetical example of a local bakery that makes 50,000 loaves of bread each year. The fixed costs for making 50,000 loaves is $32,000 each year. The bakery’s fixed costs consist of rent, bakery equipment, taxes, insurance, and utilities. The bakery’s variable costs related to making one loaf of bread is $1.80. These costs include bakery ingredients, marketing and overhead.

The bakery has a list price of $5 for each loaf of bread it sells. Therefore, the bakery will break even once it sells 10,000 loaves of bread. All sales after the 10,000 mark will mean more dough for the bakery (pun intended). Here is the break-even point formula followed by the bakery’s results:

Fixed costs / sales price per unit – variable costs per unit.

$32,000 / ($5.00 – $1.80) = 10,000 loaves of bread

Crunching the numbers.

Conducting a break-even analysis can be very involved and time-consuming. Therefore, you might want to consider having an accountant or a bookkeeper assist you. If your small business is relatively new, say under two years old, it will be easier to calculate your fixed and variable costs. Long-established businesses typically have more financial information and profit and loss statements to review.

The formula for a break-even analysis is simple, but your results will only be accurate if your fixed and variable costs are, too. If there are any discrepancies, or if either of your cost breakdowns is missing something, you will not have a good grasp of how much sales volume your business needs for it to start generating profits.

Analyzing the results.

When you are finished with your company’s break-even analysis for a particular month, quarter or year, you will see how much you need to sell in order to reach your break-even point. The goal is to meet and surpass your break-even point sooner rather than later, so you can make more profits down the road. If you are not breaking even soon enough, or perhaps not at all, there are several things to consider.

First, take a look at your fixed costs to see if there is a way to reduce them. For example, you might have non-essential costs that can be handled in-house, outsourced to a new vendor, or even eliminated. You should not make any of these changes if they pose a risk to your business from a financial standpoint. Next, you can raise your prices. This lowers the amount of sales your company needs to make in order to break even. Pricing your products or services can be difficult, especially you are located in a highly competitive or price-sensitive market, so proceed with caution.

Finally, reducing your variable costs can boost your gross margin. Just avoid skimping on materials, supplies or equipment, as this can affect the quality of the products or services you offer, and result in upset customers.

Do not forget marketing.

Robust sales can help your small business thrive, and a good marketing campaign is the perfect complement to your sales efforts. So, do not set your marketing and sales strategies on the back burner, or ignore them altogether. Look at what is working and stick with it so that you can increase your customer base. Lastly, make regular updates to your website and blog, stay active on social media, and keep in touch with your prospects and customers by sending them periodic emails.