Breakeven in Business. What does it actually mean?
The breakeven point is that point where the total income or sales equals total costs or expenses.
The point represents the level of sales where the business makes neither a profit nor a loss.
Is this important to know?
It gives you a target for your sales each period.
It can indicate whether you need to adjust your prices and by how much.
You can see if a product line is profitable or not.
It shows you how a reduction in price or number of products sold will affect your profits.
So how do you work out the breakeven point?
First of all you will need to allocate your expenses into two categories – Fixed Costs and Variable Costs.
Look at your expenses for a period of time e.g 3 to 6 months so that you know those expenses are fairly indicative of a full 12 months.
Fixed Costs are the ones that stay the same each month regardless of how many sales you make e.g. rent.
Variable Costs change based on the units of product sold e.g. raw materials used in making your products & sales commission.
You will also need to know the price per product (unit price).
Your Breakeven Point is calculated as follows:-
Fixed Costs ÷ (Price - Variable Costs) = Breakeven Point in Units
For example, if you worked out that that your
Fixed Costs averaged out at $600 per month,
Variable Costs averaged out at $10 per product,
Price was $20 per product,
then your Breakeven Point would be,
$600 / (20 – 10)
i.e. $600/10 = 60 products would need to be sold each month in order to be making neither a profit or a loss.
From here you can then see the impact that a change in price would have on your Breakeven Point and Profit.
If your price was increased to $25 per product and the costs remained the same your Breakeven Point would then be
$600/ (25-10) = 40 products would need to be sold each month in order to breakeven.
From all of this you can see that any decision you make about pricing your product, the costs you incur in your business, and sales volume are interrelated.
So why is all this important?
If you are spending more than you make you will soon have cashflow issues. Knowing what you need in order to breakeven puts it in black and white and helps you to monitor how your business is going.
Want to know more? Call us on 0422 391 370.