Updated on November 17, 2022 by Webmaster
Table of Contents
What Is a Break-even Analysis?
A break-even analysis allows owners, managers, and other relevant parties within an organization or business to see exactly how much they need to generate in sales to cover their fixed costs. The analysis tells them how much they need to make to meet payroll and other baseline obligations and hit a zero-based budget.
What Is the Break-even Point (BEP)?
The break-even point or BEP refers to when a business or organization has covered all fixed costs through the influx of sales and other business operations. As a business owner, the moment you have completely covered your operational costs, etc., you’ve reached the break-even point.
Why Your Business Needs To Perform a Break-even Analysis
A break-even analysis provides critical information about the sales volumes and total revenue necessary to keep a business afloat or profitable. Without knowing what a break-even point is for their operations, business owners and managers may mistakenly believe their business is doing well while secretly floundering.
A break-even analysis also allows for more strategic small business administration in companies with high degrees of seasonality. Awareness of an overall annual break-even point during fluctuating seasonal sales can help provide peace of mind and sales incentives during the off and peak seasons.
When To Use a Break-even Analysis
Businesses gain immediate benefits from performing a break-even analysis. Being aware of the break-even point early on in a business’s model design, profit planning, and other early stages can help establish the viability of a business idea or plan.
In addition to adding clarity to forming a business plan, pricing strategy, etc., break-even analyses allow owners and managers to project how any operational changes may impact the business. If you add employees, change salaries, or implement new pricing models, you can use a break-even analysis to see whether you’re still going to make the bare minimum in fixed costs.
How Do You Calculate the Break-even Point?
Calculating a break-even point analysis often begins by examining a business’s profit and loss statement (P&L). The P&L is a financial calculation report that shows a company’s revenues and expenses over a set amount of time—in other words, a record of a business’s financial commitments.
Going through the P&L sorts out fixed and variable costs. Fixed costs are those businesses must pay in full each month. Variable costs are line items that may change in value with volume fluctuations. Costs such as overtime or special production might count as variable costs.
When working with a client, we organize and sort these costs and use any fixed costs to calculate break-even point numbers for a month, fiscal quarter, or year. Our break-even formula isolates the sales number, subtracts the variable costs, and derives a contribution margin. From this point, we determine the break-even sales.
How Can You Use the Results of a Break-even Analysis To Make Decisions for Your Business?
An early break-even analysis can give detailed financial projections for a fledgling business. By performing a break-even analysis during the planning stage, owners get a realistic idea of any potential financial strain so they can lower fixed costs if needed before launching. These reports can also help determine how much startup capital a business needs to manage production and other fixed costs during initial operations.
Performing monthly break-even costs once a business is underway helping to keep an eye on how changes in fixed costs, variable costs, and sales impact the business’s break-even potential. In this way, break-even analysis helps influence business decisions involving selling prices, overtime management, new business directions, and more by highlighting the benefits or financial toll each decision could provide.
What Is a Standard Break-even Period?
Most businesses can hit the break-even point within six to eighteen months of operation. We believe that knowing the break-even point from the very beginning helps you achieve that goal faster and work on it on a month-by-month basis, making adjustments as necessary.
Over What Period Should I Expect My Business To Break Even?
Your business needs to meet or surpass the break-even point every month. Having startup funds to compensate for low initial sales revenue can help if your business needs to build up to hit the margin of safety. However, consistently hitting and surpassing the break-even point increases the potential for net profit and provides better margins overall.
What Information Is Needed To Perform a Break-even Analysis?
We use the following formula elements to perform a financial analysis for break-even potential.
Fixed Costs
Fixed costs include the total costs for all expenses you must pay every month.
Variable Costs
Variable costs change with the amount of output your business performs. The number of units produced or sold and any additional costs inflate the total expenses in the form of variable costs.
Price Per Unit
Price per unit is the amount a business charges for a unit sold. Think of price per unit as a sales price measure.
Costs Per Unit
Costs per unit refer to the amount of money a business must spend to create, obtain, and market a unit. Variable cost per unit includes special upticks in production, limited-run changes, temporary work, etc.
Profit Margin
The profit margin is the amount sales revenue exceeds production and general operating costs.
Raw Material
The changing costs of raw materials contribute to the total variable cost of multiple products and services.
Labor Cost
Some labor costs fall under the category of fixed costs. However, temporary work and overtime are variable costs and must be excluded from a break-even point formula.
Who Can Help Me Perform a Break-even Analysis?
Our team at Margin Authority performs break-even analyses for our clients regularly and knows the ins and outs of the process.
How Can I Validate Whether My Break-even Analysis Is Correct?
At Margin Authority, we complete analyses and check our work to ensure our figures result in a P&L of zero.
Is There a Time When It’s Not Appropriate To Do a Break-even Analysis?
The answer is none. A break-even analysis is a key performance indicator for any business.
Are There Disadvantages to Using a Break-even Analysis in Strategic Planning?
A break-even analysis offers critical insight into business performance and can strengthen business planning at all stages. There are no disadvantages to it.As part of our profit planning services, Margin Authority uses a tried-and-true break-even analysis formula to help businesses stay aware of when they are making or losing money. For more information about profit planning services, reach out to our team today.