Reviewing the breakeven point of your business is a relatively simple calculation that can provide decisive insights in regard to business performance and forecasting.
The breakeven point is that point where total revenue equals total costs or expenses. The point represents the level of sales where the business makes neither a profit nor a loss. Additional sales beyond this point will result in profits.
For new businesses breakeven analysis is a critical part of the business plan to work out sales volumes required to meet costs and establish whether a business idea is worth pursuing or whether the business can continue operations. For existing business it can assist in setting revenue and cost targets and to determine the amount by which sales can drop before losses begin to be incurred (the breakeven margin of safety).
A key to calculating and understanding the breakeven of your business is reviewing and analysing the required operating costs of your business. Broadly costs can be classed as either fixed or variable in relation to sales. Fixed costs largely remain the same irrespective of sales levels, such as rent, insurance and management salaries. Variable costs directly depend on level of sales and increase with each dollar or unit of sales. Examples of variable costs include stock purchases, manufacturing costs, distribution costs and direct labour.
Breakeven point can then be calculated in sales dollars as follows:
|Breakeven ($)||= Fixed Costs ÷ Gross Profit Margin|
|Gross Profit Margin||= (Sales – Variable Costs) ÷ Sales|
For example if a business has fixed costs of $60,000, sales of $300,000 and variable costs of $210,000 its breakeven point is calculated as follows:
|Gross Profit Margin||= ($300,000 – $210,000) ÷ $300,000|
|Breakeven ($)||= $60,000 ÷ 30%|
From the above we note that $200,000 is the breakeven point meaning that any sales below this point will result in a loss and any sales above $200,000 will result in a profit. The amount of actual sales above the breakeven point is known as the breakeven margin of safety and is $100,000 in this example (Sales of $300,000 less breakeven of $200,000).
Understanding the breakeven point of your business can assist in:
- Determining level of sales required to make a profit
- Setting realistic sales budgets and targets by showing how profits are impacted at various sales levels
- Identifying cost reduction strategies through understanding key profit drivers including level of fixed costs and average sales margins
- Understanding required sales volume or price increases required to offset impact of cost increases.
To assist in working out the breakeven point of your business you can use our simple breakeven analysis template.
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