“Will I break even?” is one of the biggest questions you should be asking yourself when starting a business.
Luckily, you don’t need to sit around and wonder for long — conducting what’s called a “break even analysis” can help you determine fixed and variable costs, allowing you to set your prices appropriately and forecast when your business will actually become profitable.
But before you can conduct a break even analysis, you need to be able to calculate your break even point (BEP).
Your break even point shows the sales your business needs to make in dollars or units before your expenses are covered and you can start making a profit.
I’m going to walk you through two basic BEP formulas you can use to help you find the break even point for your business. One is based on the number of units sold, the other is based on sales dollars. However, there are a few important terms you should know before we jump in. Let’s go through those quickly first:
Your fixed costs are costs that do not change with sales or volume because they are based on time. Traditionally, you’ll look at monthly fixed costs when plugging your numbers into the BEP formulas I’ll be sharing. Monthly fixed costs include expenses such as:
- Loan payments
- Salaried employees
- Property taxes
- Interest expenses
- Website hosting, e-commerce, online payments
Your variable costs are costs that change with sales or volume. They are based on the production of one unit. Here are the expenses to consider when looking at variable costs:
- Raw materials used in the creation of one unit
- The amount paid to workers for one unit completed
- The amount paid to salespeople if they sell a unit
- Maintenance supplies for production variable machinery per unit
- Shipping cost per unit
Your contribution margin is the difference between the price of your product and what it costs to make that product. Your contribution margin can be summarized formulaically as (sale price per unit — variable cost per unit) / sale price per unit.
Now that you know all the important terminology you need, let’s actually go through the two different ways you can calculate BEP for your business.
How to calculate BEP based on units:
To calculate break even point based on units of product sold, you’re going to want to divide fixed costs (overhead expenses) by the unit selling price minus the cost of the unit to produce. To make this a bit easier to process, let’s turn it into a formula.
BEP = Overhead Expenses / (Unit Selling Price — Cost of Unit to Produce)
Remember, you can only use this formula if you already know the unit’s sale price and cost price plus the price of business operating expenses. If you’re wanting to find your BEP to help you determine some of those numbers, move on to the next formula option.
How to calculate BEP based on sales dollars before net profit:
To find your BEP based on sales dollars, you’ll want to divide your fixed costs (your overhead expenses) by what’s called your “contribution margin.” In simple terms, your contribution margin is the difference between the price of your product and what it costs to make that product. Your contribution margin can be summarized formulaically as (sale price per unit — variable cost per unit) / sale price per unit. Here’s what this looks like when you put it all together:
BEP = Fixed Costs/Contribution Margin
BEP = Fixed Costs/[(Sale Price Per Unit — Variable Cost Per Unit) / Sale Price Per Unit]
Once you have your break even point, you can actually begin to conduct a thorough break even analysis. This is incredibly useful to add to your business plan and comes with a multitude of benefits, including but not limited to:
Finding your BEP will help you price your products based on profitability and psychology.
The way you feel is important, but sometimes important business decisions surrounding your finances shouldn’t be rooted in emotion. Knowing your BEP will allow you to navigate decision-making for your business with all of the facts in mind.
The early stages of starting a business can come with a lot of excitement, but when it comes down to it, you won’t move forward if you aren’t able to fulfill all of the financial commitments necessary for your business to succeed. Conducting a break even analysis will make your financial obligations clear to you, helping you avoid unwelcome surprises in the future.
A break even analysis mitigates risk by showing you when it’s better to avoid a potential business idea.
Upon completion of your break even analysis, you’ll know exactly how much you need to sell in order to be profitable, in turn allowing you to set sales goals for your business that will motivate you and help you reach new milestones.
If you ever want to seek outside funding from investors or banks, a break even analysis isn’t optional. This is what will prove that your business plan is actually viable and worthy of financing.
In addition to knowing how to calculate your BEP, you’ll also want to learn how to find your profit margin and markup. Knowing these numbers is invaluable in the grand scheme of business and will set you up for profitability far down the line.
If numbers aren’t your strong suit, don’t stress. I always suggest work alongside an expert in this area, such as a consultant or accountant, who can help you ensure that your calculations are correct and your numbers make sense. This is a service I offer via my strategy sessions — in just ninety minutes, we’ll conduct a thorough break even analysis and come up with a pricing plan that serves your business and will put you on track to reach your goals sooner rather than later. Click here to learn more about booking an intensive!