## Startup Basics – How To Do A Simple Break-even Analysis

2 Responses »
Apr 012011

It’s amazing how many startup entrepreneurs do not take the relatively simple, but very important step of doing a basic break-even analysis on their business. Here you will learn how to do a very basic break-even analysis for your venture.

First, it will be important that you understand the meaning of a few terms:

Selling Price: this is the price at which you will sell your product or service.

Fixed Costs: these are costs that are the same regardless of how much you might sell. Typical examples would include facility rent, insurance (like property and general liability), utilities (may be variable in some businesses), etc. Just bear in mind that if it does not change regardless of how much you sell, it likely should be categorized as a fixed cost.

Variable Costs: these are costs that vary depending on how much you sell. Some common examples include direct material costs (if manufacturing products), sales commissions, direct labor (for either manufacturing or providing services), cost to purchase products or services for resale, etc. Remember that if the cost varies in relation to the amount you sell, it is likely to be considered a variable cost.

Contribution Margin: the difference between Selling Price and Variable Costs. So, if you are selling something for \$100 and the Variable Costs of that sale are \$60, then the Contribution Margin is \$40.

Now that we have the basic definitions out of the way, let’s talk about how to calculate your break-even point in terms of both dollars of sales and units.

The formula to calculate the break-even point is very simple, as follows:

Break-even point = Fixed Costs / Contribution Margin

Let’s look at a straightforward example. Let’s say that you are running a business that has fixed costs of \$10,000 per month and you are selling a product or service that has a Contribution Margin of \$40. The break-even point in this example would be:

\$10,000 / \$40 = 250 units

If the units sell for \$100 each, then the break-even point in sales dollars would be 250 units x \$100 per unit, or \$25,000 per month of sales.

As mentioned above, this is a very simple example. There can be many nuances in the break-even calculation, but this example gives you an idea of how the break-even point is calculated. I encourage you to do such a basic calculation for the business you are considering starting, or for the business that you are already running. Understanding both the unit sales and dollar sales necessary to break even gives you a good frame of reference for the results you need to achieve to begin to make your business successful. Remember, you must reach break-even of course, before you can become profitable.

Paul Morin
CompanyFounder.com
paul@CompanyFounder.com

## As an Entrepreneur, a Detailed Understanding of Your Cost Structure is Key

Aug 112010

One of the most common afflictions I’ve seen in companies that get themselves into trouble, is that they do not understand their cost structure.  In other words, they could be “shipping a dollar bill out with each order” and not even know it.  In our consulting operation at Wharton Entrepreneurial Programs, a very common occurrence was for a client to come to us stating that they had a sales and marketing problem.  The symptom was that they had very bad cash flow, and they immediately jumped to the conclusion that they were in that predicament because they weren’t selling enough product (or service).  Very often, when we’d go in and do some basic analysis, we’d quickly realize that if we helped them with the problem they thought they had, we’d only accelerate their demise.  The reality was that they did not understand the profitability of their products or their customers, so there was a real danger in just trying to sell more – what if by chance you started to sell a lot more of a particular product or service on which you were losing money with every sale – it could quickly put you out of business. They also often did not understand the concept of a break-even analysis and the difference between fixed costs and variable costs.  Make sure you understand where your business is making money and where it is losing money; without this knowledge, you are trying to sail the entrepreneurial sea without the navigational equipment and data you need.

## As a Small Business Keep Fixed Costs Low, Especially Initially

No Responses »
Aug 102010

It is hard to over-emphasize the importance of this one.  Almost without fail, you will have surprises in your venture, particularly during the early stages.  It typically takes twice as long to achieve half the results you were expecting.  With this in mind, it’s not hard to understand why it is important to keep your fixed costs low initially.  Fixed costs – the ones you have to pay regardless of how many sales you generate, can sink you quickly if you don’t have an unending supply of outside cash, which is hardly ever the case.  You will need to take on some fixed costs, without a doubt, but don’t take on any more than you have to in the early stage of your venture, otherwise you may not be able to weather the challenges that are sure to arise.

Later in the venture, having more fixed costs (or “operating leverage”) may not be a bad thing; in fact, it can increase your profitability dramatically when times are good.  But as the saying goes, “a rising tide buoys all boats” – it’s only when the tide goes out that you figure out what lurks below the surface.  Don’t kid yourself into thinking you are invincible, based on your performance when times are good – prepare to weather the inevitable storms that will come your way — always keep your fixed costs at a reasonable and manageable level.

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