A break-even analysis may sound intimidating for the uninitiated but there’s nothing terrifying about it. It’s like trying to figure out how many waffle cones to sell to cover the costs of your business, or how many hours you would need to work as a freelancer.
It’s also a good way to gauge the best pricing structure for your company’s services.
Starting out you’ll need three basic pieces of information:
- Total Fixed Costs
- Total Variable Costs
- Selling price of the product(s)
Costs such as your rent, utilities, and payroll will relatively stay consistent every month. If your business is already using an accounting software, you can often find the monthly total under Total Operating Expenses in your system’s income statement.
Variable costs are basically the costs that go into the final product that is being sold. This could involve sales commission, payments to a manufacturer, or costs of the ingredients to make a milkshake. This information can also be found in your monthly income statement if you are using any accounting program.
I cannot say there is a right or wrong answer to how a business approaches their pricing, although it goes without saying that you should definitely price higher than your costs, but not too high that people refuse to pay for your services. In order to get a better idea, start looking at either a competitor’s pricing or informally inquire how much people would pay for your service or product.
Break- Even Analysis
Break-Even Quantity (BEQ) = Fixed Costs/ (Price – Variable Costs)
Basically, the break-even quantity will let you know how many units will be necessary to cover your costs. Any number beyond BEQ is considered profitable, but it is the exact opposite if the numbers are below the BEQ.
You are running a food truck business selling tacos. Fixed costs from running the business are about $1,050 per month, $2 for the costs of making one taco, and $4 to sell one taco.
$1,050/($4-$2) = 525 tacos a month required to break-even.
Although what if you found a way to drive variable costs down by $.50 because you were able to get a better deal with your supplier:
$1,050/($4-$1.50) = 420 tacos a month required to break-even
That’s 125 lesser tacos to sell , but now what happens when the price goes up by $.20, and fixed costs by $50.00 to account for a wage increase:
$1,100/($4.20-$1.50) = 408 tacos a month required to break-even (Had to round 407.41)
You can see that slight adjustment I made to the price and costs with varying results. To see if this formula really does break even, let’s take the previous example of 408 tacos:
408*$4.20= $1,713.60 Sales
408*$1.50= – $613.00 Cost of Goods Sold
$1,100.60 Gross Profit
– $1,100.00 Operating Expenses
$0.60 Net Income
The food truck business will not only break even from selling 408 tacos but also will earn a $.60 surplus in profit.
Calculating Multi-Product Businesses
Calculating the break-even point for businesses that carry more than one product isn’t that difficult either, but may be a little cumbersome. This article below does a great job of explaining how to do a break-even analysis with multiple products:
In all, a break-even analysis is a great way to assess how many sales a business needs to be able to sustain itself without any personal financing.