Understanding Your Breakeven Point
Breakeven with your pricing - An Inflation Series Article
Do you know your business breakeven point?
Knowing how much income you must generate to cover all fixed and variable costs means you can make better business plans and financial decisions for long-term sustainability and profit.
> The breakeven point is the income or sales needed to cover all costs.
>Any earnings above this point generate profit.
>The breakeven point tells you the minimum sales required to continue operating a viable business.
Understanding the breakeven point in conjunction with financial reports can give you valuable data to analyse fixed and variable costs and set sales targets for the business or individual staff members.
Fixed and Variable Costs
Fixed costs - remain the same regardless of how many sales you make. Expenses like rent, equipment lease repayments or full-time staff have to be paid whether you sell any goods or services or not. Fixed costs are often called overheads.
Variable expenses - (sometimes called production costs) fluctuate based on sales. For example, cost of goods sold, production labour, and commissions paid to salespeople will vary according to the number of goods or services sold.
It's helpful to work out an amount or percentage of variable costs compared to the sale price of your products or service. This may not be exact initially, but even if you get a rough figure to work with, this will help calculate your breakeven point.
Over time as you analyse your financial reports, you’ll be able to refine the calculation and adjust your selling price accordingly.
How to Calculate Breakeven
First you will need to know your fixed costs (overheads), selling price and production costs.
One common method of calculating breakeven is as follows:
Overheads / (average sale price – variable costs)
Your break-even point is equal to your fixed costs, divided by your average sale price, minus variable costs. The second part of this equation (average price – variable costs) is also known as the contribution margin. This number tells you how much cash you have leftover to go towards your fixed costs.
For example, let’s say
> overheads per month (rent, vehicle lease, administration staff) are $20,000.
> your average coaching service is $3,000.
> your variable costs (fees, handout materials for participants, advertising) of $1,500 per program.
$20,000 / ($3,000 - $1,500) = 13.33
You would need to sell over 13 coaching programs per month to break even, which equates to $40,000 worth of sales.
If the same program had variable costs of $1,800, you would need to sell 17 programs per month to generate $50,000 worth of monthly sales just to cover costs. Variable costs of $1,000 per program would mean you only need to sell 10 per month to break even.
With these examples, you can see how important it is to understand your fixed and variable costs. Then you will know how much you need to make to remain in business and the resulting impact on your financial position.
Once you have a reasonably accurate breakeven figure, you can calculate your profit before tax for sales above the breakeven point.
In the example where variable costs are $1,500 per program, let’s say you sell 20 programs each month. This would result in an extra $10,000 in profit (before tax) after paying for overheads and variable costs.
Can breakeven help with your pricing?
Understanding your breakeven point can give you some deep insights into your selling prices, helping you understand if they’re realistic.
For example, if your variable costs are high, how much more income will you need to reach breakeven. Is there a fair price for consumers that covers your expenses in a reasonable time frame? Do you need to raise prices to account for fixed and variable costs accurately?
Make adjustments where required
To improve your profitability, you might decide to reduce your expenses, increase your rates or offer add-on services.
See what happens if you adjust some of the numbers in the equation. What makes you more or less profitable?
Things to keep in mind when doing a break-even analysis.
A break-even analysis is a great tool for business owners and it plays an important role in how you make decisions, but it isn’t fool-proof.
Multiple services with multiple prices. Many business owner don’t have an ‘average price’ – the cost of a job depends on labour and materials. You might need to work with one job at a time – and calculate a break-even price for each type of job.
When prices fluctuate, so do costs. This model assumes that only one thing changes at a time. Instead, if you lower your prices but win more work, your variable costs might change because you’re able to work more efficiently with another employee. Ultimately, it’s only an estimate.
Demand isn’t stable. A break-even analysis won’t tell you what your sales are going to be, only how much work you need to win to run a business that doesn’t cost you money. Any adjustments you make in your prices will in some way affect demand.
Ignoring time and competitors. It’s not unusual for your work to fluctuate seasonally or for changes in the market to affect your pricing and sales. A break-even analysis will give you a good understanding of what your baseline is but will need to be used in conjunction with cash flow management and sales forecasting.
Don’t forget expenses. Your break-even result will only be as good as your data. That means accurate expenses are crucial for a reliable break-even analysis.
Measuring your margin of safety
Think of a break-even analysis as a safety net. It tells you how many jobs you must win to cover the fixed and variable costs of running a successful business.
To ensure you’re always making business decisions based on the most accurate information, update your break-even analysis regularly. It is only an estimate, but for new businesses, it’s a great way to gauge when you will break even – and turn a profit.
Talk to us about calculating your breakeven point
There are different ways of calculating your breakeven point to confirm the viability of your business, and the ideal pricing point for driving both sales and profitability.
We would love to help you understand your business financials in more depth, so you can plan for long-term sustainability, enjoyment and profitability.
BE THE FIRST TO KNOW
Subscribe to receive future reports.
Complete the form below to receive timely and insightful information directly to your inbox. Make sure you never miss an update.
