The right business idea will thrive in any economy. But no idea is good enough if the numbers don’t make sense. One of the best first things you can do with your business plan is calculate the break even point. It’s one of the most important numbers you’ll ever crunch. Predicting a precise amount of revenue is impossible, and variables are constantly changing, but a break even is a great benchmark for any business.
How to Calculate Break Even
How many products or services do you need to sell in order to stay in the black? You can get a good idea by using simple model to calculate the break even point. This calculation determines the number of units that must be sold in order to recover all costs:
Break Even = Fixed Cost / (Unit Price – Variable Unit Cost)
The key to calculating break even is understanding the way certain expenses behave in relation to revenues. In a break even analysis we analyze how expenses change relative to sales. The two types of expenses are:
- Variable expenses change as sales increase. These costs vary the production of each additional unit sold. The cost per unit is expressed as a Variable Unit Cost. Variable expenses might be materials used in production, or commissions on services sold.
- Fixed expenses do not change as sales increase. Fixed expenses are the total of all costs involved in producing even ONE unit of a product. This number doesn’t increase until the volume sold is high enough to require new capital expenditures to meet the demand. Examples of fixed expenses are rent on office or manufacturing plant space and interest on debt.
Some expenses will be a mix of fixed and variable expenses. Salaries might have a fixed component (wages) and a variable component (commission or bonus). When calculating break even, you’d want to separate out these type of expenses into their separate components of fixed or variable cost.
Plugging in the Numbers
You can calculate break even easily on a piece of paper, but if you’re hand with a spreadsheet it’ll be easier to play with the variables.
To get revenue, simple multiply the number of units sold or clients serviced (expected unit sales) by the unit price (amount charged to customer).
Total Variable Cost is calculated by multiplying the number of units sold by the variable unit cost.
The break even is a nice way to find out how sensitive your business idea is to various changes. You can make all kinds of decisions based on this information. Should you get the larger space or the smaller space? Hire two employees or three? Raise or lower your prices? (Of course that will adjust your expected sales, but that’s another calculation!)
Has calculating a break even ever helped you out in a new business venture? Or do you think it’s a complete waste of time? Let us know in the comments.