How to Perform Break-Even Analysis

How to Perform Break-Even Analysis

Performing a break-even analysis is one of the most crucial parts of any good business plan, in fact, the break-even analysis can be very helpful even before you develop a simple business plan. Developing a break even analysis is just a matter of doing simple math if you can accurately determine the cost and sales analysis of your business.

The main purpose of performing a break-even analysis is to determine accurately when you can expect your business to meet all expenses and start generating profit. That is why it is important that you can determine the cost and the project sales figures.

Defining Costs for Break-Even Analysis

When performing the break-even analysis example you will need several types of cost. The most relevant cost are the fixed costs, the variable costs, and the average price per unit.

  • Fixed costs. The fixed cost is those costs that remain the same regardless of how many products you sell. The ones like rent, insurance, and administrative payroll are considered fixed cost because these does not change much from month to month and you have to make these outlays before selling it. You also have to include everything including deposits or contingency funds.
  • Variable costs. The variable cost is those costs that are considered to be a recurring cost that must be absorbed with each item you sell. Inventory, shipping, and sales commissions are examples of variable costs because these figures also rise or fall along with your sales volume.
  • The average price per unit. Among the three types of costs, this is the trickiest. You also need to consider the cost of pricing an item or unit. After you have set the pricing of your products, The next that you should do is to start looking the pricing of the competitor and how they price their products

How to Do a Break-Even Analysis

Performing a break-even analysis is simple, just take fixed costs, then divide by your price minus your variable costs. If it is a form of an equation, it should look like this:

Break-even Point = Fixed Costs/(Unit Selling Price – Variable Costs)

The above equation will determine the break-even quantity or the number units of a product you need to sell to cover your costs. When you reach this point, you will find out all the cost affiliated with producing your product. All the sales that are above are pure profit. Anything below, means you are losing profit.

Limitations of Break-Even Analysis

The break-even analysis could really tell you about your business and you must pay attention to what this analysis is telling you.

For example, if the calculation tells you that you break even when you sell a specific number of units, then your next step is to evaluate if it is possible.

If you think that you can not sell that specific number of units, due to its large amount, within a reasonable period of time analysis, then it may not be the right business for you. However, if you think you could but you need time, then you must lower the price of the units and calculate a new break-even point.