Conducting a Break Even Analysis: Know Your Bottom Line

If you own a business but haven’t done a break-even analysis, then you have no idea how much of a profit you are making, nor do you know where your bottom line is.  It’s sort of like driving a car with a broken gas gauge.  A break-even analysis is a process in determining the point at which a company begins to make a profit, despite its operating expenses.  The break-even point is the point in which sales revenue is equal to the total cost of a product or service.  Beyond this point is profit, under it is loss.

The first step in doing a break-even analysis is determining your company’s fixed and variable expenses.  Some expenses may be both fixed and variable.  For example, sales compensation can be a combination of a base salary plus commission.  Once you’ve determined all of your expenses, you’ll have some calculating to do.  Think of it as a mathematical equation.  Take your fixed expenses then divide that number by your selling price (per unit) and then minus your variable expenses.  If you’re having difficulty getting an exact number, don’t worry.  There are many factors that can influence a break-even analysis. The goal is to get as close to the actual number as possible so you have a realistic estimate.

An important term to know is Contribution Margin.  This is the product or service revenue minus the variable expense per unit.  Therefore, the break-even point is the total fixed costs divided by the contribution margin per unit.

If you can’t figure your variable expenses because they’re too unpredictable, just take your total expenses for a given period of time, such as one year, and divide that number by the total units sold for that same period of time.  For example, if your company sells skin care products and your annual operating expenses (rent, salaries, packaging, raw materials, utilities, legal fees, etc.) cost $1 million and you sold 250,000 tubes of lotion in a year, your break-even point is $4 per tube.  If you sell your product for $5 per tube, your profit is $1 per unit or $250,000 for that year.

If your company provides a service, such as a medical office, and your annual operating expenses are $1 million, you would have to provide 10,000 treatment sessions at $100 just to breakout even.  Better raise your fee to $150.

It’s important to perform regular break-even analyses over the course of time because, as your expenses change, so will your break-even point.  Don’t mistake your break-even point with your payback period which is the time it takes to recover an investment.  That is also an important figure to calculate but for a different reason.  If you are writing a business plan, it’s a good idea to include both of these calculations as they are not only important to investors (if you are seeking venture capital) but also good to understand the challenges associated with your startup or running your existing business.

For more information on how to perform a break-even analysis, please contact Ashlar Consulting Corporation at 305-849-9399 or visit www.AshlarConsultingCorp.com.