As an entrepreneur, break-even analysis is of great significance for you.
While, from the outside, break even analysis may “just” be the moment when a company makes absolutely no money, for someone starting a business, the break-even point is their first objective: the moment when costs equal revenue.
Fixed costs – those costs that you have to pay, regardless of whether you sell a single product or service unit. These are for example the rent on the premises, the permanent staff wages, and other regular bills.
Variable costs – those bills that rise with the quantity sold. In the example below we run a burger joint, so our variable costs are the burgers, the buns etc etc
BEWARE: some items like labour can be partly fixed, partly variable, as you may have to have someone at the premises at all times whether you have any customers or not (fixed costs) but when you are busier than normal you may need additional staff (variable costs.)
The next step after an organisation reaches that precious break even point is usually the one towards profitability – the purpose of every healthy business. Once the fixed and variable costs are paid for, then the rest goes towards profit. It is a fact that a company needs a certain level of sales to cover its costs. To calculate the actual timing when that business may break-even, you must understand and assess fixed and variable costs.
Let’s say you own a burger bar company. Then, you might have the following costs:
What you understand by looking at the figures above is that you have to place your final pricing higher than £4.60, which is the variable cost of each burger, to start to cover part of the fixed costs as well, so, at the end of the month, both fixed and variable costs are covered, and above that is profit.
If your price for the burger menu is £16, then, for each burger sold, £11.40 goes towards covering fixed costs and then towards profit (£16 – variable costs £4.60)
So, to work out your breakeven point, you need to sell 480 burgers monthly, which is 480×4.6 = £2208.00 + fixed costs of= £5472.00 = £7680
To ensure this is correct, 480 x selling price (£16) = £7680
Break even is also a great tool to help you understand what your final pricing should be. For example, if you raise your prices but keep the costs the same, you will pay off the fixed costs quicker and more quickly head towards profits (unless you start to lose customers due to the price rise.)