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.

If you have questions about this example or some of the nuances you are encountering as you try to do a similar calculation for your business, don’t hesitate to contact us and enter your comments/questions below.

Paul Morin