Breakeven analysis – when can you start making money
For a Chief Financial Officer of a company, profitability is sure to be front-of-mind. Even if you have a great product and are generating consistent sales, many business owners and key decision makers can find themselves surprised that their business is still not making them any money.
According to the US Small Business Administration, breakeven analysis is a great tool to determine the point at which your business is generating revenue at least equal to expenses. Any additional revenue can at this point be considered profit. It is critical if you are just starting your business to identify and incorporate startup costs into this calculus, as initial upfront investments can be significant and will affect net sales revenue needed to break even.
The calculus is a little more complicated than some might expect, and often you need more sales than you might initially anticipate. For example, if you have $10,000 in inventory sales, you typically will not have enough to break even with $10,000 in overhead costs. There are associated costs for selling $10,000 of inventory, which could easily be in excess of $5,000 at wholesale prices. So, the $10,000 in inventory sales might only generate $5,000 in profit. Again, the breakeven point is the threshold at which total revenue is equal to total expenses.
To calculate the breakeven point for your business you will first need to identify fixed costs and variable costs. Fixed costs are costs which will not change with scale of total sales volume. This can include expenses such as staff salaries and administrative costs. Independent of sales – or lack thereof – these expenses have to be paid. Oftentimes, fixed costs are referred to as overhead costs.
On the other hand, variable costs will change as a result of changing sales volumes. Sell more, and your total variable costs generally go up. Sell less, and they will generally go down. Variable costs can include such expenses as purchasing inventory, shipping, and manufacturing.
To determine the breakeven point for your business, use the following equation:
Breakeven point = Fixed costs / (Unit selling price – Variable Costs)
For example: Let’s say Mom and Pop’s Bicycle Store has fixed costs which are calculated to be $100,000 per month. This includes the lease to the store, salaries, property taxes, etc.
Their product – as their name suggests – is their bicycles, which they sell for $250 a piece. The variable costs for each bicycle are $50.
To calculate the breakeven cost for Mom and Pop’s Bicycle Store see the formula applied below:
Fixed costs / (Unit selling price – Variable Costs) = Breakeven point
$100,000 / ($250-$50) = 500 units
So, Mom and Pop’s Bicycle store would have to sell $500 bicycles per month to break even. Every bicycle sold after that nets them a profit of $200!
For CFO’s looking for help with these kinds of calculations, Sageworks’ financial analysis suite takes financial data and quickly converts it into plain-language reports with industry comparisons, ratio analysis and trend analysis along with recommendations for improvement. The analytical solutions are designed to be intuitive and to make financial reports more accessible to non-financial colleagues.