The breakeven point shows you how much product you need to sell in order to cover the cost of doing business. It can also be used to determine when your business will start to make a profit.
Therefore, it’s no surprise that breakeven analysis is a key component of most business plans, especially for startup companies. After all, it helps to predict whether your business idea will be viable or not.
Keep reading to learn how to calculate the breakeven point for your small business.
How to Calculate the Breakeven Point
Your company will break even at the point when revenues and expenses are exactly the same.
In order to calculate the breakeven point, you need to have a few numbers handy:
- Fixed costs – as the name suggests, these expenses remain constant regardless of output, e.g. rent, insurance premiums, payroll, shipping costs.
- Variable costs – are tied to production levels and rise as your sales volumes increase, e.g. hiring freelancers to handle an unusually large order.
- Selling price – this is the amount you charge customers for a single unit of your product.
Breakeven point (in units) = Fixed costs / (Selling price per unit- Variable costs per unit)
Pro tip: Input your fixed costs, variable costs and selling price into a spreadsheet to ensure that your calculations are accurate. Using a spreadsheet will also enable you to seamlessly plot a graph to show the breakeven point at different sales volumes and prices.
Dianne is a cake shop owner who wants to determine how long it will take to break even. Her fixed costs are $5,000 per month. It costs her $8.75 to make each cake which she then sells for $25.
Using the breakeven point formula, Dianne must sell approximately 308 cakes per month $5,000 / ($25-$8.75) in order to sustain her business. From here, Dianne can also determine the required sales volume per week (77 cakes) and per day (10 cakes) assuming that Dianne’s Cake Shop opens every day of the week.
Ways to Lower Your Breakeven Point
The lower your breakeven point, the faster your path to profitability. You can either adjust your pricing strategy, lower your fixed expenses, cut production costs or a combination of all three.
Adjust the price per unit
With an understanding of how to calculate the breakeven point for your small business, you can now set a price that helps your company breakeven faster. For example, if Dianne increased her price to $30, her breakeven would now be 235 units. But is $30 a realistic price to market her baked goods?
Overall, the most effective pricing strategy will incorporate a mix of qualitative and quantitative factors taking into account:
- the competitive landscape;
- the perceived value of your product; and
- your business goals.
Reducing fixed costs
For many companies, staffing costs make up the biggest line item when it comes to their fixed expenses. But, identifying areas where staff functions can be automated or replaced with an outsourced function can help to significantly improve your breakeven point. After all, having fewer fixed costs means you need to sell fewer units of your product in order to cover them.
You could also consider reducing the cost of your monthly lease by moving to a cheaper location or subletting your current space if possible in order to lower your fixed costs.
Increasing the contribution margin
If you’ve already successfully lowered your fixed costs or if you are unable to lower them any further, then you might turn your attention to your variable expenses next. The contribution margin represents the amount of money a company has to cover its fixed costs after it pays all of its variable expenses. The equation is:
Contribution Margin = Sales revenue – Variable costs
Using the original example above, let’s assume that Dianne realizes that she will only be able to sell 300 cakes in a given month and that she is unable to lower her fixed costs below $5,000. Her contribution margin would be $7,500 – $ 2,625 = $4,875. This indicates that Dianne is heading for a loss because her contribution margin is insufficient to take care of her fixed expenses.
Net Profit or Net Loss = Contribution margin – fixed Cost
However, if Dianne were able to cut production costs by $2 per unit by finding a cheaper baking ingredients supplier, the new contribution margin would be $7,500 – $2,025 = $5,475 for a net profit of $475 ($5,000 – $5,475). Making such a change highlights the company’s operational efficiency and puts Dianne on a much faster profit trajectory.
Breakeven Analysis and Startup Costs
Business owners can also tweak the breakeven calculation to determine the sales volume required to recoup their initial investment. Simply use the dollar amount of the initial investment in place of fixed costs as follows:
Breakeven point (in units) = Initial Investment / (Selling price per unit- variable costs per unit)
Using our fictional example above, let’s suppose that Dianne invested $20,000 in industrial grade kitchen equipment prior to officially launching her business. In this case, she would need to sell 1,231 cakes in order to earn back her investment.
Understanding how to calculate the breakeven point for your small business is just one key component in conducting cost-volume-profit analysis. If you don’t have a background in accounting or if you would rather spend your valuable time as a business owner on revenue-generating tasks, then you might consider the services of a virtual CFO. By hiring a part-time, remote CFO, you can reap the benefits of an in-house CFO, at a fraction of the cost. You won’t have to worry about costs associated with a salaried employee such as paying for travel time, benefits, insurance, or payroll taxes.
At Remote Quality Bookkeeping, we offer virtual CFO services to review key metrics and ratios per month or per quarter including the breakeven point. The best part? Our plans are customizable, which means you only pay for the exact CFO services you need.
Let us provide you with the financial expertise you need to strategically manage your business growth. Contact the team at Remote Quality Bookkeeping today to find out more about our virtual CFO services.