Every business owner wants to know what their break even is for their company, but many don’t know where to begin trying to calculate it. Doing a break even analysis will provide information regarding the sales volume needed to be at a break even status (no profit or loss).
The two things you need to calculate first are your fixed costs and variable costs.
- Fixed costs normally do not vary at all as long as the sales are in a reasonable range. These are overhead costs that the company has to incur whether they have any sales or not. Some examples of fixed costs are: rent, management payroll, interest, insurance, utilities and depreciation.
- Variable costs are directly proportional to the sales volume of a company. Sales are what create the variable costs. Some examples of variable costs are: direct materials costs, equipment costs, hourly wages for workers, sub-contractor costs, fuel and sales commissions. Once you know your variable costs, you need to figure out what the percentage of your variable costs is related to the sale. If costs are seventy-five cents to make a product you sell for a dollar, you would have a 75% variable cost.
After calculating the fixed costs, variable costs and variable cost percentage, the calculation is as follows:
Fixed costs divided by (1 – variable cost percentage) = sales needed to break even.
If the fixed costs are $10,000 per month, and the variable cost percentage is 75%:
$10,000 / (1 – 75%) = $40,000 in sales needed per month to break even.
Doing break even analysis aids in setting appropriate prices for products and services. It will help businesses ensure they don’t lower prices to a point where they discover there won’t be enough volume to maintain previous profit levels.