What is a Break-Even Analysis?

what is a break-even analysis

Have you ever wondered, “what is a break-even analysis?” or “why is my business not breaking even?” If so, you are not alone. Countless small business owners are not familiar with the break-even analysis. Moreover, they are often perplexed as to why the combination of their fixed 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 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 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 your break-even point, you will need to conduct a break-even analysis, which is the focus of this Balboa Capital blog article.

Calculating a break-even point.

Your break-even point is the intersection at which your fixed and variable costs meet and match in terms of the dollar amount to your sales revenues. To calculate your break-even point, you need first to 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 cost 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

Break-even analysis: 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. However, long-established companies 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.

Break-even analysis: Analyzing the results.

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

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 number of sales your company needs to make to break even. Pricing your products or services can be difficult, mainly if you are located in a highly competitive or price-sensitive market, so proceed cautiously.

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 a perfect complement to your sales efforts. So, do not set your marketing and sales strategies on the back burner or ignore them altogether. Instead, look at what is working and stick with it to help 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.