Understanding the total costs involved in launching a business and bringing a service or product to market can be a stumbling block for many entrepreneurs. Crucially, this impacts on pricing, with many people in business discovering that they cannot sell enough of their service or product to break even or make a profit.
It is vital for a business to know its break even point, because this will determine pricing and profitability.
Benefits of a Break Even Analysis
“For some people in business, they place so much emphasis on the inspirational nature of what they do, and the drive behind it, that they miss out on the essentials,” Hywel cautions.
“Someone might feel they have a unique selling proposition, something that will differentiate them in the marketplace and, ultimately, make a good profit. Without a break even analysis, this is not much more than conjecture”
“Obviously, there will be an element of educated guesswork at the start,” says Hywel, “but you should back this up with solid research. This means a thorough analysis of your market.”
Two basic factors determine a break-even point: anticipated revenue, and the costs of doing business.
Largely, anticipated revenue is down to market demand: the more people demanding your services or products, the greater your sales volume. The greater the sales volume, the sooner you can cover your costs.
“There are going to be several factors affecting this, including what you have to offer, the size of your target audience, and the effectiveness of your marketing and promotional activity,” states Hywel.
These different factors will come into play over time, affecting the overall revenue your business can expect to generate.
“Of course, then there are your costs to consider,” Hywel cautions.
The Costs Involved
Businesses will have startup costs and fixed and variable costs associated with their day to day running.
“Startup costs can have a huge impact on your break even point. The less you need to start running your business, the sooner you are likely to break even”
On top of this are fixed and variable costs for a business. Fixed costs can include things like utilities and building rent, which will be there regardless of business activity. Variable costs can run from day to day operating costs to buying stock.
“The higher your overheads, the longer it will take you to break even,” Hywel comments. “Another contributing factor will be your pricing strategy.”
The higher the mark-up on a product, for example, the higher the gross profit to set against variable costs. This must work in relation to the target audience and market conditions, however.
You calculate your break-even point by dividing fixed expenses by margin. The margin comes from subtracting total variable expenses from net sales.
“It’s a foundation for making important business decisions,” Hywel advises.
“Your break even point can help determine how you reduce and control your fixed costs,” concludes Hywel. “Control these costs and you can reach a lower break even point to go into profit more quickly.”