BREAKEVEN ANALYSIS: HOW TO KNOW WHEN TO EXPECT PROFIT IN YOUR BUSINESS

Breakeven Analysis: How to Know When You Can Expect a Profit - This has been a serious part of any business. Most people jump into businesses and expect to start getting profits from the business immediately without knowing when the business will break even. This has lead most people to failure in their business. As an entrepreneur, you need to know how to calculate the financials of your business so that you will know when it will start yielding profits. We have added three different articles on break even analysis we got from different sources to assist you.


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ARTICLE 1 

Breakeven analysis is used to determine when your business will be able to cover all its expenses and begin to make a profit. It is important to identify your startup costs, which will help you determine your sales revenue needed to pay ongoing business expenses.

For instance, if you have $5,000 of product sales, this will not cover $5,000 in monthly overhead expenses. The cost of selling $5,000 in retail goods could easily be $3,000 at the wholesale price, so the $5,000 in sales revenue only provides $2,000 in gross profit. The breakeven point is reached when revenue equals all business costs.

To calculate your breakeven point, you will need to identify your fixed and variable costs. Fixed costs are expenses that do not vary with sales volume, such as rent and administrative salaries. These expenses must be paid regardless of sales, and are often referred to as overhead costs. Variable costs fluctuate directly with sales volume, such as purchasing inventory, shipping, and manufacturing a product. To determine your breakeven point, use the equation below:

Breakeven point = fixed costs/ (unit selling price – variable costs)

ARTICLE 2

How to Calculate Breakeven Point

How to calculate breakeven point is a key financial analysis tool used by business owners. Once you know the fixed and variable costs for the product your business produces, or a good approximation of them, you can use that information to calculate your company's breakeven point. It is a popular tool used by small business owners to determine how much volume of their product they must sell in order to make a profit.

 It is also an important part of cost-volume-profit analysis.

One thing is sure. In order to know how price your product, you first have to know how to calculate breakeven point.

What is Breakeven Point?

A company's breakeven point is the point at which its sales exactly cover its expenses. The company sells enough units of its product to cover its expenses without making a profit or taking a loss. If it sells more, then it makes a profit. On the other hand, if it sells less, it takes a loss.

To compute a company's breakeven point in sales volume, you need to know the values of three variables. Those three variables are fixed costs, variable costs, and the price of the product. Fixed costs are those which do not change with the level of sales, such as overhead. Variable costs are those which do change with the level of sales, such as cost of goods sold. The price of the product has been set by the company through looking at the wholesale cost of the product, or the cost of manufacturing the product, and marking it up.

How to Calculate Breakeven Point?

In order to calculate your company's breakeven point, use the following formula:

Fixed Costs/Price - Variable Costs = Breakeven Point in Units

In this formula, fixed costs are stated as a total -- the total fixed costs for the firm. Basically, this means the total overhead for the firm. Price and variable costs, however, are stated as per unit costs - the price for each product sold and the variable cost for that unit of the product. The denominator of the equation, price minus variable costs, is called the contribution margin. In other words, this is the amount, per unit of product sold, that the firm can contribute to paying its fixed costs.
An Example of Breakeven Point

XYZ Corporation has calculated that it has fixed costs that consist of its lease, depreciation of its assets, executive salaries, and property taxes. Those fixed costs add up to N60,000. Their product is the widget. Their variable costs associated with producing the widget are raw material, factory labor, and sales commissions. Variable costs have been calculated to be N0.80 per unit. The widget is priced at N2.00 each.

Given this information, we can calculate the breakeven point for XYZ Corporation's product, the widget.

Fixed Costs/Price - Variable Costs
N60,000/N2.00 - N0.80 = 50,000 units

XYZ Corporation has to produce and sell 50,000 widgets in order to cover their total expenses, fixed and variable. At this level of sales, they will make no profit but will just breakeven.
What Happens to the Breakeven Point if Sales Change?

What if your sales change? For example, if the economy is in a recession, your sales might drop. If sales drop, then you won't sell enough to make your breakeven point. In the example of XYZ Corporation, you might not sell the 50,000 units necessary to breakeven. In that case, you would not be able to pay all your expenses. What can you do in this situation?

If you look at the breakeven formula, you can see that there are two solutions. You can either raise the price of your product or you can find ways to cut your costs, your fixed and/or your variable costs.

Let's say you find a way to cut the cost of your overhead or fixed costs by reducing your own salary by N10,000. That makes your fixed costs drop from N60,000 to N50,000. The breakeven point is, holding other variables the same,:
N50,000/N2.00-$0.80 = 41,666 units

Predictably, cutting your fixed costs drops your breakeven point.

If you reduce your variable costs by cutting your costs of goods sold to $0.60 per unit, then your breakeven point, holding other variables the same, becomes:
N60,000/N2.00-N0.60=42,857 units

From this analysis, you can see that if you can reduce the cost variables, you can lower your breakeven point without having to raise your price.

Relationships Between Fixed Costs, Variable Costs, Price, and Volume

As the owner of a small business, you can see that any decision you make about pricing your product, the costs you incur in your business, and the resulting volume that you sell are interrelated. Calculating the breakeven point is just one component of cost-volume-profit analysis.

You also have to consider how you allocate costs in your business - the direct and indirect costs - that contribute to overhead.

Running a business is complicated. We can help. Contact Us and get tips and insights from our small business experts, delivered straight to your inbox.

ARTICLE 3

Break-Even Calculator

Break-even analysis is an expected component of most business plans, especially for startup companies. This calculator helps determine your company's break-even point, the amount of revenue you need to generate to cover your fixed and variable costs.

What is a break even analysis?

A break even analysis tells you how much you need to sell in order to cover your costs of doing business. A break even analysis is particularly useful if the products or services that you sell have costs associated with them, such as the costs of buying materials for your products. This is because every product you sell generates an additional cost - the cost of buying the materials for your product. So, the more you sell, the higher your expenses will be.
What do you need to know to calculate your break even point?

In order to calculate your break even point (the point where your sales cover all of your expenses), you will need to know three key numbers.

Average Per-Unit Revenue

This is how much money you receive, on average, for every product or service that you sell. Be sure to count any discounts or special offers that you may give to your customers.
 
If you are building a break even analysis for your entire company and you sell multiple products or services, you will need to figure out the average selling price for all of your products or services, combined. Don’t worry, this is a pretty common scenario since most companies sell multiple products.

Average Per-Unit Cost

This is how much it costs you to deliver your product or service. If you are buying products and reselling them, this number is what you paid to purchase those products. If you are making your own products, your per-unit cost should include the costs of the materials it takes make your product. Typically, salaries are excluded from this number.
 
If you are selling services, this number is what it costs you to deliver your services. This might include the costs of paper or other materials you use when you are presenting to a client, or the cost of gas that it takes you to drive to a typical client.

Monthly Fixed Costs

In a text-book break even analysis, fixed costs would be defined as the expenses you have even if you don’t sell a single product. Those expenses might include things like rent and insurance. Instead of this text-book definition, we recommend using your regular running costs such as payroll and other normal expenses - what would normally be your “Operating Expenses” on a profit and loss statement.
 
Don’t worry about getting this exactly right. A good estimate is usually good enough.

Once you know these three numbers, you are ready to perform your break even calculation. Using the calculator above, plug in your numbers and see how many units (ie. products) you have to sell in a typical month to cover your costs. The calculator will also tell you the total revenue you will need to bring in to cover your fixed costs PLUS the costs of delivering your product or service.

Your break even point is where the line on the chart crosses the zero line.

Sources and References
http://bizfinance.about.com/od/pricingyourproduct/a/Breakeven_Point.htm
http://www.bplans.com/business_calculators/break_even_calculator/
https://www.sba.gov/content/breakeven-analysis
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