A breakeven analysis is done to determine when your business will make enough money to cover costs and begin to make a profit. Break even analyses are performed before a business is started to gauge if the idea can be successful and it’s also done long after a company is up and running to help determine the price of new and existing products. It’s important to identify costs for any small business in the early stages.
To calculate your breakeven analysis, you’ll need a few pieces of information:
- Fixed costs per month
- Variable costs per unit
- Average price per unit
Fixed Costs do not change from month to month. They include costs associated with rent, payroll, insurance and taxes, along with much more. No matter how many units you sell, your fixed costs will remain the same. When starting a business, it’s important that you don’t roughly estimate what your fixed costs will be. To figure out your fixed costs, call your insurance broker and get an estimate, call the utility company and find out what your utilities will likely cost and heavily research any other industry costs you may incur to ensure your calculations are correct.
Variable costs are recurring costs that are directly related to your sales. If you’re selling more products, your variable costs will go up and if your sales go down, so will your variable costs. Variable costs include things such as production supplies, credit card fees, labor and direct materials. To estimate your variable costs, do some research on your industry and talk to vendors to see what others in similar situations are paying. You can often reduce variable costs easier than fixed costs. For example, you may be able to find a lower cost supplier to manufacture your products easier than you can find a cheaper location or decrease your number of employees.
Average unit price is the amount you will charge your customers to buy one unit of your product. Setting the right price for your products is crucial to your businesses success as well as your breakeven analysis. The price of your product is what will determine when your startup will begin to turn a profit. To learn how to price your product, look at your competition and how they price their products. You can also create focus groups with potential customers to see how consumers accept the price of your products. After you’ve figured out how much it costs to produce one unit of your product and you’re still unsure of the exact amount to charge, a breakeven analysis can help.
To Perform a Breakeven Analysis
Breakeven point = Fixed costs / (Average price per unit—variable costs per unit)
For example, let’s assume you’re starting a small bakery and selling your home-made baked cakes. You have $1,000 per month of fixed costs (bakery rent and equipment and utilities). Your variable costs for the baked goods are $30 for labor and materials. You’d like to charge $50 per cake since that’s the going rate in the area for home-made cakes.
Breakeven point = $1,000 / ($50-$30) = $1,000 / $20 = 50
This means you’d need to sell 50 cakes each month at $50 per cake to break even. Startup owners can use this breakeven formula to compare different pricing strategies to analyze which price points will work best. The higher you make your prices, the harder it may be to attract buyers, but if you keep your prices low, you’ll have to sell more products to turn a profit. You can also examine the differences in your breakeven point if you can decrease your variable or fixed costs. To be able to investigate these different scenarios, use these free and helpful breakeven templates online.
Once you understand the outcomes of a few different options of your analyses, you must determine if the prices are attainable for your business. Can you produce as many products as you need to in one month or year to break even? If none of your analyses are doable, you may need to look into other business ideas or determine where you can cut costs to meet your breakeven point. It’s important to understand that a breakeven point is not a predictor of demand. If demand is super high, you may be able to get away with a lower price, or if demand is low, you may not ever be able to break even. Research on your industry and target audience is the best way to determine if your breakeven point can be met to turn a profit.