Knowing your break-even point is crucial anytime you need to make a decision that may help or hinder profits. You'll also improve the accuracy of your budgeting and forecasting, allowing you to set realistic goals for future growth.
Use this guide to calculate your break-even point and begin to take advantage of monitoring this key performance indicator.
Step 1: Know your fixed costs
Your fixed costs are the set expenses required to run your business each month. They include fees associated with operating out of your office or retail space, like rent or a portion of your mortgage if you use a home office.
For example, insurance, utilities, phone bills, Internet service, employee salaries, any business loan payments, and general office and administrative expenses all fall under the category of fixed costs.
On a piece of paper or in a spreadsheet, make a list of all your fixed expenses and the monthly cost of each. It's a good idea to add 10% to allow for unpredictable miscellaneous expenses.
Step 2: Estimate your variable costs
Variable costs are the incremental expenses associated with producing each additional unit or providing one more service. For example, your variable costs may include a sales commission payable when a salesperson closes a deal. Or, the cost to ship your product for each additional unit sold.
Determining an accurate cost per unit will help you price your products to earn a fair profit.
Itemize your variable monthly expenses alongside your fixed costs. With these two sets of numbers, you can now calculate the number of units you need to sell to reach your break-even point.
Step 3: Calculate your break-even point
To find the point at which you are no longer operating at a loss, plug in your current unit price to the following formula:
Fixed costs / (unit price - variable costs)
Let's use a jeweler specializing in custom-designed rings as an example.
Fixed monthly expenses: $1,000
Variable expenses: $100/item
Current selling price: $200/item
$1,000/($200 - $100) = $1,000/($100) = 10
By pricing rings at a 100% mark up, the jeweler has to sell 10 rings each month to break even. With this information she may decide to:
- Find less expensive suppliers (or less expensive labour) to lower variable expenses
- Increase her marketing budget to bring in more customers and earn more by sales volume
- Raise prices so she will have to sell fewer items to earn a profit each month
Now that you know how to find your break-even point, you can contemplate these changes in your own company to help improve profitability and grow your business.
