5 Easy Steps to Creating a Break-even Analysis
Determine profitability with a break-even analysis
Break-even is one of those vital numbers that can mean success or failure to a small business. If you are breaking even your profits are equal to your costs. But, above the break-even point, every dollar of sales is pure profit.
A break-even analysis is important in several different situations:
- As your business plans new products. Knowing the break-even point helps you price more efficiently.
- As you plan your overall business cash and profit strategy. While break-even isn't the same as profits, it can be used to determine profit points for product lines.
- As your business plans for financing. Having an overall company breakeven point can help make your case for a business loan.
Information from a Break-even Analysis
If you are producing and selling products, you need to know if these products are profitable. Creating a break-even analysis will give you the information you need on profitability. You should construct a break-even table to show break-even points for various sales volumes and unit prices for each product.
A lender or investor will probably want to see this information in the financial report section of your business plan. But you should have this information to help you determine the optimum sales price for each product, to reach maximum revenue by setting the price at the point where revenue is at its highest.
5 Steps to Creating a Break-even Analysis
Here are the steps to take to determine break-even:
- Determine Variable Unit Costs.
Determine the variable costs of producing one unit of this product. Variable costs are those costs associated with making the product or buying it wholesale. If you are making a product, you will need to know the cost of all the components that go into that product. For example, if you are printing books, your variable unit costs are paper, binding, and glue for one book, and the cost to put one book together. Let's say you calculate your unit variable cost at $11.50.
- Determine Fixed Costs
Fixed costs are costs to keep your business operating, even if you didn't produce any products. To determine fixed costs, add up the cost of running your factory for one month. These costs would include rent or mortgage, utilities, insurance, salaries of non-production employees, and all other costs. In other words, fixed costs are all costs of your business except those directly related to producing your products. Let's say you determine your monthly total fixed cost at $25,000.
- Determine Unit Selling Price
Determine the unit selling price for your product. This price may change as you see where your break-even point is, but for now, let's say your unit price is $25.00 per book.
- Determine Sales Volume and Unit Price
The break-even point will change as the sales volume for this product and the unit price changes.
- Create a Spreadsheet
To do a break-even calculation, you will construct or use a spreadsheet then turn the spreadsheet into a graph. The spreadsheet will plot break-even for each level of sales and product price, and it will create a graph showing you break-even for each of these prices and sales volumes.