How to Calculate Your Break Even Point and Why It Matters

All business start-ups face a number of challenges, many of which loom much larger for MWBEs. Access to capital is certainly one of the most significant, as is finding mentors who can offer sound, meaningful advice. But let’s assume for now that you’ve secured the funding you need to get your business going and have put together what you believe are solid business and marketing plans. You’ve got a growing client list and a few sales under your belt, and it seems to you that your start-up is going to succeed. But you still ask yourself: How do I know for sure if I’m making enough money to keep my business viable? To answer that question, you need to calculate your break even point, or the point at which your revenue is sufficient to cover all of your business costs.

To determine your break even point, you must first so a thorough and realistic assessment of your projected revenue and expenses. As a start-up, you don’t have a great deal of historical data to help you with this, so you’ll need to complete a market analysis to get a clear idea of what to expect. Market trends, target demographics, industry trends and seasonality are just a few factors you’ll need to consider if you want to accurately project how much revenue you can bring in and how much doing so will cost.

How to Do a Break Even Analysis

Doing a break even analysis involves analyzing your estimated revenue and your estimated costs and doing a mathematical comparison of the two. It’s not difficult; you just need to crunch some numbers using a little basic math. The hard part of the process is being honest with yourself. As a start-up business owner, it’s easy to be too optimistic, which can land you in financial trouble in the end.

Here are the numbers you will need to look at:

Fixed costs: This should be a relatively simple calculation, since fixed costs don’t change all that much. They include things like rent on your business property, insurance premiums, monthly payments on business automobiles, the cost of raw materials and the salaries of any permanent employees. Add these up, then throw in a little cushion of 10 to 15 percent for unexpected expenses just to be safe.  

Sales revenue: This is simply how much money you anticipate bringing in. You can calculate the amount on a monthly or yearly basis. As a start-up, it may be easiest to calculate it month by month.  

Average gross profit for each sale: This number represents how much you actually keep from each sale you make. For example, if you charge $1,500 for a high-tech widget that costs you $1,000 in materials and labor to make, your average gross profit is $500.

Average gross profit percentage:  This is simply the percentage of the money from each sale that is gross profit. To calculate this number, divide the average gross profit by the average selling price. Using the above example, you would divide $500 by $1,500 to determine that your average gross profit percentage is 0.333 or 33.3 percent.

Calculate Your Break Even Point

Now that you’ve got the numbers down, it’s time to calculate your break even point. To do this, divide your estimated monthly (or annual) fixed costs by your average gross profit percentage.

So, let’s say your fixed monthly costs average $6,000. Using the above example, you would divide $6,000 by 0.333. The result, $18,018 is the amount of revenue you need to generate on a monthly basis to reach your break even point.

Remember, too, that the break even point is simply the point where your revenue covers your cost of doing business. It does not include any profit, nor does it include a salary for you.

Now What?

If your break even point is about what you expected, then it’s safe to say you can continue doing business as you have before. But what it it’s too high?

Obviously, there are two general approaches to this problem: increase revenue or decrease costs. To achieve the former, you can raise your prices, but this may be a hard-sell if you’re just starting out. You can also use some creative strategies to up-sell your clients in various ways. Can you  a offer a two-year service contract at a reasonable price? How about bundling the widget with some software that you buy from a third party on a per-unit basis (thus not contributing to your fixed costs)? 

If increasing revenue simply isn’t possible or if the projected increase falls short of your break even point, you may need to make some difficult decisions about where to go from here. Some questions to ask yourself include:

  • Can I give up my office space and work from home?
  • Can I refinance my auto loan, or negotiate a less expensive lease?
  • Do I need to let an emplyee go?
  • Can I outsource some of my fixed costs?
  • Can I find a cheaper supllier for my materials?

In the end, if you can’t come reasonably close to your break even point in any of these ways, then your start-up is probably doomed to fail. Although it will be painful, you may need to cut your losses now before you invest more of your time, energy and money into a venture that can’t succeed.

About The Carmoon Group

The Carmoon Group Ltd. is an insurance broker located in Hicksville, New York. Our professional staff has over 20 years of experience helping small businesses make sound decisions and plan successfully for growth. Whether you’re an entrepreneur just starting your business or a seasoned pro, we’re here to help. Just give us a call to set up an appointment for your insurance review, or reach out online and we’ll get back to you as soon as we can.

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