How to Calculate the Break Even Point for Your Company

|Aug 14, 2019

Making a Profit Is the Next Step After You Break Even

The whole point of being in business is to make a profit. But sometimes, especially when you’re first starting out, that isn’t always possible. The secret to staying in business is to first stem your losses. Ideally, you’ll want to turn that loss into a profit, but first you’ll have to break even.

This isn’t as simple as you’d think. In this article, we’ll go over the break even point formula so you can figure out how to turn a profit with your business.

How to Calculate a Break Even Point

The break even point occurs when a business makes enough revenue to cover their costs. Note that a profit hasn’t been made at this point, but it’s usually the next step.

First, you must add up all your fixed expenses. Typical fixed expenses might include:

• Rent
• Utilities
• Staff wages
• Equipment costs
• Loan payments
• Insurance
• Depreciation
• Manager salaries

Next, it’s time to look at variable expenses. These tend to fluctuate with the number of units sold. Note that most of the time production costs per unit will decrease as more product is produced.

Typical variable expenses will be:

• Cost of raw materials
• Labor to put the product together
• Travel
• Marketing and promotion

You’ll notice that advertising is in the fixed cost category, while marketing and promotions are variable costs. All three can be variable costs. Advertising is usually easy to cut when times are bad. However, a business should never abandon marketing completely, or else it could start a death spiral of epic proportions.

Entrepreneurs should note that fixed costs will mostly stay the same, whether your business produces one unit or 100. This is why it’s important to keep those expenses as low as possible when you’re first starting out.

Say I want to make coffee tables. My fixed costs are \$5,000 per month for the shop, my staff, and so on. If I only make one coffee table, that piece of furniture will need to sell for \$5,000 plus the cost to produce the item in order for me to break even. If it costs \$500 to make one unit, I have to sell it for \$5,500 to break even.

That’s obviously not a viable business plan.

But what if I make 50 coffee tables per month? This brings down my break-even point to \$600 per unit: \$100 per table in fixed costs and \$500 per piece in variable costs. If I can sell each one for more than \$600, I’ve done even better; I’ve made a profit.

There’s just one problem. Figuring out my costs is relatively easy. All I need to do is come up with a business budget and stick to it. But how does a business owner accurately forecast revenue? This is the tricky part of a break even formula.

The bane of every good break even point formula is when sales start to falter. This increases your fixed costs per unit and can throw your whole business into chaos.

Figuring out your top line is notoriously tough, especially for new entrepreneurs. How can one forecast sales when there’s no data to back anything up? It’s basically a wild guess.

The first tip I’d give new business owners is to be conservative. Build your business to be able to withstand lower than expected revenue, especially in the first few months of operations. Take your first three months’ worth of sales expectations and slash them in half, then build your business accordingly.

This is when doing your market research is important. Find out how many sales your competition expects in a typical week. Surpassing your rivals is a reasonable (and motivating) long-term goal, but don’t expect it to happen right away. Happy customers aren’t going to stampede over to your new product even if you give them a compelling reason to switch. It’s a process that takes time.

Another way to get an idea of your potential sales expectations is to research a competitor operating in another city, in a market that has similar characteristics to your home. You’d be surprised how much employees will tell you if you make a visit and start asking questions. After all, you’re not much of a threat.

Some entrepreneurs find value in having two sets of sales projections. One is a conservative measure, while the other takes a more aggressive approach. Since business can go up and down seemingly randomly, switching from one forecast model to the other can keep a business owner sane.

One last piece of advice is to make sure you have enough start-up capital to endure worse than expected conditions. If business takes off, you can always invest that excess cash into expanding operations. And if it doesn’t, your business can survive while you figure out the next step.

Getting Back on Track

What should you do if sales aren’t quite up to expectations?

This sounds counterintuitive, but the first step should often be spending more money. A good marketing campaign at the right time can save a business. Many new ventures panic and cut their advertising spending, which decreases new revenue sources.

One of the most difficult decisions for a struggling entrepreneur to make is whether more capital should be injected into a money-losing business. The time to make this decision isn’t when the owner is panicking. This decision should have been made months beforehand, when calmer heads ruled the day.

Further to this, have additional sources of capital lined up before you need them. It’ll be a lot less stressful this way.

Falling into money-losing mode is also a great time to look at your fixed expenses. Perhaps a staff member isn’t working out, or the company has too much space. These might be big changes, but they could literally be life or death decisions for your organization.

A riskier move is to try raising your prices. Many first-time entrepreneurs are convinced undercutting the competition is their ticket to success. This often backfires, especially when they don’t have a low-cost business model. Besides, customers will often conclude something is wrong with a discount version of the same product.

The Bottom Line

Your business needs to do a break even analysis before it even opens its doors for the first time. Yes, it really is that important. Opening a new venture is hard enough. The last thing you want to do is put more of your hard-earned capital into it.