One very useful tool for a business is a “breakeven analysis.” What exactly is a breakeven analysis? It’s similar to what you think of it as for your personal finances (bills equal income coming into your household). Your breakeven point is when your business costs equal business income. There are no profits, but there are also no losses. The breakeven point will give you an idea of where your business is and where it can go. Often, businesses are first aiming to breakeven (often for the first year of ownership), then make profit once this point has been hit.
Your breakeven analysis is the first step in planning for future growth. It shows how much sales volume you need to cover fixed and variable costs. Once your company has reached breakeven, all gross profit beyond that point goes directly to improving the bottom line.
When would you use the breakeven analysis? Most often, a breakeven point is used as a point of reference for:
Startups/new small businesses
Expanding or downsizing of current businesses
When approaching banks and other potential lenders for business loans
A breakeven analysis helps with many business choices. However, it does have limitations such as:
- Ignoring the importance of cash flow.
- Making assumptions that fixed and variable costs will stay within the parameters that were used to calculate the breakeven point.
As a business scales, variable costs tend to increase rather than decrease, therefore making your breakeven point shift.
Breakeven Point Calculation
The first place to start when calculating a breakeven point is to look at your annual financial statements. Your financial statements will reveal your fixed costs and variable costs.
- Fixed costs do not vary in relation to sales volume. Some examples of fixed expenses are things such as rent, utilities, insurance, and depreciation.
- Variable costs are the cost of goods sold and other costs of sales, such as direct labor and sales commissions.
- Some costs may be part fixed costs and part variable costs. You will need to split these into separate categories based on your knowledge of your business as the business owner.
The last step is to calculate your company’s breakeven point! To do this, find your gross profit percentage by dividing your net sales less your cost of goods sold (COGS) by your net sales. Then divide fixed costs by your gross profit percentage to finally arrive at breakeven.
For example: If your fixed costs are $10,000 and your gross profit percentage is 25%. Your breakeven point is sales of $40,000 ($10,000 ÷ 25% = $40,000).
If you find that you are far from reaching your breakeven point, it may be time to cut costs. By doing so, you will inch much closer to profitability which is a must for the survival of your small business.
For help determining your breakeven point and creating a financial growth plan for your business, reach out to Anders. We specialize in startups and entrepreneurs!
