WHY YOU NEED TO KNOW YOUR BREAKEVEN

Oftentimes in business, important metrics are overlooked and oversimplified. Understanding breakeven is a crucial part of any business’ financial health and can greatly impact the business’ ability to gain meaningful profits and lower costs.

WHAT IS BREAKEVEN?

A business’ breakeven point refers to the point that which a business sells enough of its product or service to cover its costs — any sales after this point are profit. Breakeven can be calculated by how many units need to be sold or how much revenue needs to be generated to cover costs.
 
Unit Breakeven = Fixed Costs / (Selling Price – Variable Cost)
Revenue Breakeven = Fixed costs / ((Selling Price – Variable Cost)/Selling Price)

FIXED VS. VARIABLE COSTS

If you are unsure how to populate the formula above, you may be confused about the difference between fixed and variable costs.
 
Fixed costs are the unchanging expenses you pay whether you make a sale or not. This includes rent, employee salaries, and advertising costs. On the other hand, your variable costs refer to the expenses that change in proportion to the output of your production. This can include packaging, shipping, commissions, and more.
 
Take a look at your business, list all your costs, and categorize them accordingly to conduct accurate breakeven analysis.

WHY IS BREAKEVEN IMPORTANT?

Breakeven analysis is a vital metric to finger the pulse of your finances. It allows you to understand your business’ current profitability and discover areas where you may be able to eliminate or lower costs.
 
If you are selling many products, understanding your breakeven point may highlight the value of economies of scale for your business. Strategize on lowering your variable costs at scale or eliminating unnecessary fixed costs to increase your profitability.

HOW TO APPLY BREAKEVEN ANALYSIS TO YOUR BUSINESS

Breakeven analysis looks different for different businesses — a coffee shop will have very different costs than a barbershop, particularly because one produces products while the other performs services.
 
Let’s take the coffee shop for instance and assume they have 1 kind of coffee and 1 employee. Each cup of their specialty coffee costs $5 to make (milk, sugar, coffee beans, whipped cream, etc.) and is sold for $10. The combined cost of the employee salary and rent is equal to $15,000. 
 
Applying the formula above $15,000 / ($10 – $5), the coffee shop needs to sell 3,000 cups of coffee to cover their variable and fixed costs. The coffee shop owner can now look at this and conduct an audit to lower costs. 
 

Questions he may ask now are:

  • Can we bulk order coffee beans at a lower cost?
  • Can the rent payment go down?
  • Can we hire employees at a more cost-efficient rate?

Conclusion

Your competitors are constantly revisiting their breakeven and finding opportunities to lower variable and fixed costs. Conduct breakeven analysis using the formula above and truly understand the health of your business.

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