The Value of Break Even Analysis

Your break even point is probably one of the most valuable pieces of information when managing your business. Let’s start with a simple definition: break even point is a level of sales which you need to generate to cover all your variable and fixed costs and break even. That means that the business has not made any money and it has also not lost any. Your profit is zero – you broke even.

Calculating Break Even Sales Point

How is break even sales point calculated? With 3 elements:

Sales

Variable Costs

Fixed Costs

The accuracy with which you calculate each of these elements is critical and will determine how accurate the results of your break even calculation will be, so make sure your financial information is reliable.

Variable Costs

Your variable costs will be those which most closely follow your sales – if sales go up, they will go up as well. They will most typically consist of labor and materials. If you have a production facility, they will also include direct and indirect overhead for that portion of your overall facility costs.

To give an example, if you sell certain widgets, you will first have to buy them from a vendor. That’s a variable cost – the more you sell, the more you will need to buy. If you sell services, the variable cost will be the time of your service providers.

Once you have established what your variable costs are and you know your sales, you will be able to calculate your margin. This should be done at the individual product level as well as on the larger level (product groups and total company).

Fixed Costs

Your fixed costs are the last element of the break even analysis. They are those costs which typically stay fixed, regardless of your sales levels. Expenses such as rent, utilities, telephone, insurance, administrative staff, etc fall into this category.

Again, be sure that your accounting records are accurate and that you can rely on the numbers you will be using in your break even calculations.

The Result – Your Break Even Point

The amount of sales needed to generate enough margin to cover your fixed costs is your break even point. So, as you can see from the previous sentence, your margin and your fixed costs will both influence your break even point.

Break even analysis will then consist of using that break even sales point by individual products, by product groups and your total business to make some intelligent decisions regarding your product pricing, your variable costs and your overhead.

Calculating your break even point will focus your attention on the key components of your business in a way that is bound to discover non-performing SKUs, areas of overspending and unprofitable customers.

Based on the result of the break even analysis, you will be able to set better targets for different levels of profit you want to achieve. And you will know how to achieve your targets, because you will be very familiar with the driving factors behind it by now.

Many business owners cannot arrive at an accurate break even, because they don’t have accurate margin information for their products. Once their inventory get a little complex, they may lack the commitment or the discipline to establish accounting systems to track those costs and calculate product by product margins.

So, the mere fact that you have an accurate break even sales point means you have done a lot of good homework and know your numbers pretty well. The break even analysis is really the crowning of all that effort and the reward you now richly deserve.

Once you have all the needed pieces, break even analysis will be the kind of financial information you will never want to be without!