It is important to pay attention to your business’ breakeven point. Here we'll explain how to work out your breakeven point and why it's such an important thing to keep an eye on. If you know what you have to do to break even, then you know what you have to do for your business to survive, and furthermore, what you can do to succeed and make a profit.
What is breaking even?
Breaking even is when a business’ net income is zero and income is equal to outgoings. When a business breaks even, it is the first positive sign of potential for making a decent profit. When a business first starts out, its outgoings are almost always much higher than any income from sales. This is usually due to a lot of initial costs like renovating premises, advertising, developing a website etc. Until your business becomes better known, it can take some time to bring in a steady stream clients/customers. A business has to reach its breakeven point for it to ever be profitable. Unless your business consistently has income higher than its outgoings, it will never be self-sufficient.
How do you work out your break-even point?
To work out your businesses breakeven point you need to take note of the services/products your business provides, how much you sell them for, and the different expenses relating to them. Every business has fixed expenses and variable expenses, which are both important when working out your business’ breakeven point.
Imagine you are selling a product. Each product you sell will have expenses that relate to the production and selling of it. Let’s say you sell a watch for £100. The materials you bought for that one watch cost you £15. That is a direct variable cost. This is because the cost of materials will go up the more watches you sell. Another expense related to the watch is rent of the premises where you manufacture the watch. This is a fixed expense. Unless your business grows to a size where your premises are no longer big enough, it doesn’t matter how many watches you sell, the rent will still cost the same. In order to work out your breakeven point, you have to add up all of your fixed costs and divide them by the selling price less your variable costs.
Let’s look at the example of the watch making business in more detail:
Fixed costs in the year:
Premises rent: £24,000
Variable costs per watch:
Operating costs: £6
Your breakeven point is FIXED COSTS/(SELLING PRICE-VARIABLE COSTS)
So, this means that you need to sell 493 watches in the year to breakeven.
Why is it important to know your businesses breakeven point?
If you want to move premises, buy a new computer, employ a new member of staff, or you are thinking about spending money on anything else, knowing your breakeven point can help you make decisions. You may be unsure of whether you can afford to make a purchase, but now you know exactly how much more of your product or service you will need to sell to breakeven and continue heading in the right direction. Knowing your breakeven point also means you know how much more you will need to sell to make a profit, and if you are really struggling, it can help you determine where you can cut costs in order to keep your business afloat.
Looking back at the watch example again, now that you know your breakeven point, you also know that:
- If you sell less than 493 watches, you will make a loss, and if this continues, you’ll eventually go bust.
- If you sell exactly 493 watches every year, your business can continue surviving, but you will never make a profit.
- If you sell more than 493 watches, you will make £71 profit for every watch you sell!
This information is essential for your businesses financial planning, as without it you won’t know what your sales targets should be, and you won’t know whether you need additional finance to fund your growth.
What can you do to reach your business’ breakeven point?
One example of something you can do to get your business on its way to breaking even, is avoid discounting. Why? Because your breakeven point will go up. If you have already calculated your breakeven point based on selling your product at £100 each and you decide you to discount your product to £80, then you will need to sell much more of your product to breakeven (35,000/(80-29)=686). Other ways to get closer to breaking even are to minimise expenses, focus on selling products and services with a high gross margin, try to increase sales from existing customers.
This has been a brief overview of what it means to breakeven and why it is important. If you'd like more info on this issue then please give us a call on 0131 445 1825 or email firstname.lastname@example.org.