One of the primary goals of any small business is to become profitable.
But how can you know when this is actually happening?
Performing a breakeven analysis of your small business is a great way to see exactly when your business will start generating enough revenue to cover all expenses so that you can start to turn a profit.
While you might not be familiar with this process, it is, fortunately, fairly simple to do. By becoming familiar with the formula and understanding what factors impact your breakeven point, you can easily perform your own breakeven analysis.
What is a Breakeven Analysis?
A breakeven analysis is a calculation that determines when your business’ revenue is equal to your total expenses. As a business owner, this can give you important insight as to how much sales revenue you need to generate to cover all of your business expenses and start to make a profit.
This calculation can also be used to help you evaluate your pricing model to boost your sales revenue.
By performing a breakeven analysis of your business, you can see exactly the number of dollars your business needs to earn in order to cover your total costs.
Breakeven Analysis Formula
Ready to perform a breakeven analysis on your business?
All you need to do is utilize a simple formula to find your breakeven point. The formula for a breakeven analysis is as follows:
Breakeven Volume = Fixed Costs / (Sale Price Per Unit – Variable Cost Per Unit)
Your fixed costs are the costs that remain the same no matter how many items you sell. This also includes startup costs like rent, insurance, equipment, and similar expenses as they are costs that need to be covered to sell your items.
The sale price per unit is the price of each unit sold.
The variable costs per unit are recurring costs that you must cover for each item you sell, meaning these costs will increase as your sales volume increases.
The sale price per unit minus the variable cost per unit is your contribution margin.
With this formula, you are calculating the total number of units you must sell in order to break even. This is the point at which you have offset all of your business expenses.
Every item sold after this point will increase your business profits by the amount of your contribution margin.
Breakeven Analysis Chart
A breakeven analysis chart is essentially a visualization of the breakeven formula.
Your expenses, as well as your income, are plotted on a graph and the point at which the two lines intersect indicates the point at which your business is not making either a profit or loss.
Using a breakeven analysis chart is a great way to see how your expenses will increase as your sales volume increases as well as how long it might take your business to achieve profitability.
This can be a great tool for profit planning as it helps you determine whether or not your business will realistically be able to generate enough revenue to reach the breakeven volume.
A Breakeven Analysis in the Real World
How does a breakeven analysis work in the real world? Let’s take a look at an example.
Say you run a business in which you sell laptop computers. You’ve determined that the fixed costs for your company add up to $30,000. This could include anything from property taxes, insurance, utilities, and any other costs that do not change as your sales volume changes.
The variable costs include the materials and labor needed to produce each computer. For example, computer parts, such as the keyboard, screen, battery, etc., would all be considered variable costs. Additionally, you would have to consider hourly labor costs.
For this example, assume your variable costs amount to $200 and you sell each laptop for $500. With these numbers, your contribution margin would be $300.
Now, we can calculate your breakeven volume using the following formula:
Fixed costs: $30,000
Sale price per unit: $500
Variable cost per unit: $200
Breakeven Volume = 30,000/(500 – 200) = 100 units
This means that, given your fixed and variable costs, you would have to sell 100 laptops to breakeven.
After reaching your breakeven volume, each additional laptop sold would increase your business’ profits by your contribution margin, or $300 in this case. If you sell less than 100 laptops, however, your business will lose money.
You can also use this information to reevaluate your pricing model.
For example, if you lower the sale price of each laptop to $400, your breakeven volume would increase to 150 units. While this means that you would have to sell more units, it may also attract more buyers and increase your sales volume.
On the other hand, if you determine that customers are willing to pay more for your laptops, you could increase your price to $600, which would lower your breakeven volume to 75 units.
A breakeven analysis can be a great way to see how your business must perform in order to turn a profit so that you can adjust your business model accordingly.
It’s Time to Make a Profit
Running a small business has its fair share of challenges. One of the biggest ones is becoming profitable.
By performing a breakeven analysis on your small business, you can see how much revenue you need to generate to turn a profit, and how you can adjust your business practices to help you reach this milestone.
At Camino Financial we strive to live up to our motto, “No Business Left Behind.” We do this by working with small business owners in a variety of industries to provide small business loans and business resources that will help them succeed, grow and thrive.