In order for your business to work, it must be able to bring in at least as much money as it spends. When a business earns as much as it spends, it is said to be ‘breaking even’. Before you enter business, you need to know how many sales you must make to break even. This can be on a weekly, monthly, or annual basis. If you can make at least this amount of sales, your idea is financially feasible.
A break-even analysis shows the minimum amount of sales that your business needs to make in order to cover all of your costs. If you can make at least this amount of sales, the idea is financially feasible. If your business is service-based and you charge by the hour, the break-even point tells you how many hours you have to charge out to customers each year (or month or week). You will need to see if this number of hours is feasible.
It is important to carry out a break-even analysis even if you intend to sell your products at prices higher than the ‘minimum price’ you calculated when pricing your products. This is because, as you increase your prices, it is likely that the quantity you sell will decrease. You need to ensure that the increase in price makes up for the decrease in quantity, and that the costs of the business are still covered.
At the ‘break-even’ point, a business does not make a loss but does not make any profit either. You will need to aim to make higher sales than the break-even point so your business will start to make a profit.
How to Conduct a Break-Even Analysis
There are a number of formulae you can use to conduct a break-even analysis. You can calculate the number of sales needed, how much you need to sell in dollar terms, or the number of hours you need to bill for to break even.
1. Calcuate the Number of Sales Required to Break Even
To calculate the break-even number of sales, use the following formula:
This formula shows the number of sales required per week. You can change it to per month or per year just by changing the figure for ‘total fixed costs’ to a monthly or yearly amount.
You can see that the formula requires you to calculate both fixed costs and variable costs.
- Fixed costs. These include ‘overhead’ costs such as rent, insurance, and administration costs. Also include any fixed salaries or wages you will need to pay and your own salary.
- Variable costs. You are likely to have some costs which will change depending on your sales quantities. For example, if you own a retail store, your variable costs will include the cost of stock you buy to then sell on to customers.
Click here for more information on how to conduct a break-even analysis using this formula.
2. Calculate the Break-even Sales Value
To calculate the value of sales needed to break even, use the following formula:
If your business will sell many different kinds of products or services at varying prices, you might find the above break-even formula easier to use. This formula shows break-even sales required as a dollar amount instead of as quantity of sales. Again, you can change the timeframe from ‘per week’ to ‘per month’ or ‘per year’ by changing the ‘total fixed costs’ figure to a monthly or annual amount.
Your gross profit margin is how much money is left from total revenues (all the money your business takes in) once you subtract the cost of goods sold. For example, if a business receives $120,000 in revenue by selling products and it costs that business $60,000 to buy those products from a supplier, then the gross profit margin equals $60,000.
3. Calculate How Many Billable Hours are Needed to Break Even
If your business charges by the hour, use the following formula:
For example, if you charge $100 an hour, and have total fixed costs of $200,000 per year, you would need to be able to charge out 2,000 hours per year to clients to break even ($200,000 divided by $100 per hour).
Allowing for four weeks of holiday, one week sick leave, and approximately two weeks of public holidays, this works out at 44.4 hours per week (2,000 hours divided by 45 weeks).
Unless you plan to employ someone else, this level of sales is not likely to be feasible. Although you may be prepared to work 44.4 hours each week, take into account that you probably will not be able to charge out every hour worked. For example, you cannot charge your customers for time you spend working on your website, answering email enquiries, or completing your GST requirements.