Every business starts out with big ambitions for taking over the world. And yet within five years, almost half of them will have shut down. Why is that?
Often, the problem is cash flow. Around 29 percent of businesses come to an end because the company failed to break even.
That?s why it?s crucial for every business owner to know their break-even point ? the point at which your income is greater than your combined outgoings. The good news is that calculating break-even point isn?t hard, as long as you have the right data.
Calculating Break-Even Point
Each business has a slightly different way of calculating their break-even point. You might focus on units, you might focus on sales in dollars, or you might look at the number of customers served.
Either way, you?ll need to start with three types of data about your business:
? Fixed costs ? the bills you have to pay every month no matter what, such as rent, insurance and loan maintenance
? Variable costs ? expenses that vary according to how busy you are, such as raw materials, labor, and energy bills
Sales revenue ? the total amount you take in, ideally broken down into units or average per customer
If you have this data in an Excel spreadsheet, you can easily build a break-even calculator to meet your needs. The more accurate your figures, the more precise the results you?ll get from the calculator.
Break-even Point Calculator by Unit
If your business sells units with a consistent price, then you can use the following formula to calculate the number of units you need to sell in order to break even:
Fixed Costs --------------------------------------- = Break-even point in units(Price per unit ? cost per unit)
For example, imagine you sell pencils at $1 per pencil. It costs $0.20 to manufacture a pencil, and your total fixed costs are $10,000 per year. That works out as follows:
———- = 12,500 pencils
So you need to sell 12,500 pencils per year to break even.
Break-even Point Calculator in Dollars
If you can?t break your figures down into a neat per-unit cost, you can calculate break-even point by looking at your contribution margin.
Revenue ? Variable costs--------------------- = Contribution margin ratioRevenue
For example, if you earned $50,000 last year and spent $25,000, the contribution margin ratio is 0.5.
You can then use this ratio to work out break-even point:
Fixed costs ? contribution margin ratio
So, if your fixed costs are $100,000 and your contribution margin ratio is 0.5, then you need $150,000 to break even.
Break-even Point Calculator by Customer Average
In a business such as a restaurant, you may want to calculate break-even point in terms of the number of guests you serve. You can work this out by adapting the formulas above to suit your needs. For example, if you know the average bill per guest and you know the average variable costs (such as labor and food items), then you can use this formula:
Fixed Costs --------------------------------------- = Break-even point in customers(Average spend per guest ? average cost per guest)
So, imagine your restaurant has fixed costs of $12,000 per quarter. The average customer spends $90, and it costs an average of $30 to serve them.
Using the formula above, that gives you a break-even point of 200, which means that you need to serve a minimum of 200 guests per quarter to break even.
What if Your Break-Even Point is Too High?
Break-even point tells you whether you have a viable business or not. If you?re not on course to clear BEP, then you?re going to start racking up debt and will eventually have to close your doors forever. You need to take action right now.
1. Identify the problem
There are only three elements in a break-even point calculation: fixed costs, variable costs, and revenues. If you?re not breaking even, then it?s because there is a problem with one of these three elements. Take a look at data involved in the break-even point calculation ? you should be able to see exactly where you?re going wrong.
2. Review your pricing
The fastest way to increase revenues is to up your prices. Take a look at what your competitors are charging and get a feel for what customers are willing to pay. If you?re charging substantially below market rate, then it may be time to review your pricing structure.
Small businesses and start-ups often charge low prices at the beginning in the hope of attracting business. This strategy can be counter-productive in the long run because it means that you need a larger customer base in order to break even. Ask yourself if there?s another way to differentiate yourself, besides having low prices. Can you offer better service? A unique experience? Can you add value in a way that your rivals don?t?
3. Try to reduce variable costs
The rule for variable costs is this: get them as low as possible, but no lower than that.
For example, you should always be on the lookout for suppliers who can offer you a great deal. However, you should never compromise on quality. It?s better to spend $2 on a steak that customers love than to spend $1 on a steak that makes your customers say, ?that?s the worst meal I?ve ever had in my life.?
Look at all of your other variable costs as well. For example, you can reduce energy bills by implementing eco-friendly measures around the building. You can also reduce labor costs by investing in training and using automa
tion where possible.
4. Invest in growth
Sometimes, your business will simply need to increase sales volumes in order to break even. In other words: you need more customers.
If you?re confident that your business model is working, then it might be time to invest in marketing. This means advertising, social media promotion, sales, discounts, loyalty programs, and any other tactic to increase revenue and get the word out about your business.
When launching a growth strategy, start off with clear goals. Do some market research to get a realistic idea of potential growth, and to figure out where to find prospective clients. If you can, consider partnering with a professional marketing agency.
5. Review fixed expenses
There isn?t a lot you can do about fixed expenses in the short-term. You may, in some situations, be able to restructure debt or haggle down your commercial rent. Generally, though, your fixed costs are precisely that: fixed.
When calculating break-even point, you may realize that the problem is that your fixed costs are far too high in relation to your revenues. If that?s the case and there?s nothing you can negotiate, then you may need to make some big decisions. For example, you may need to relocate to a more affordable premises or one where you can serve a higher volume of customers.
6. Get expert help
Why do some small businesses succeed when so many others fail?
It?s not luck ? it?s good governance and expert guidance. Successful businesses have people on the team who can help balance the books during those uncertain early years.
If you don?t have a financial expert on your team, then get someone involved, fast. Honest Buck Accounting specializes in helping Seattle small businesses. Get in touch if you?d like us to offer some advice on ways your business can break even.