Break Even Point? What Does That Even Mean?
For most of you reading this, you’re more than likely wondering what a “Break even Point” is. And how it could be any kind of benefit to your business and decision-making process. Knowing your Break Even Point is a very big part of quality small business accounting.
Well, they are two great questions, so let me explain to you what exactly a Break even Point is and how it could be beneficial to your business.
Basically, your Break even Point identifies how many sales and ultimately units would need to be sold so you can cover your fixed and variable costs. Your business’ fixed costs are items such as rent, phone plan, insurance & wages and superannuation for staff, just to name a few.
Your business’ variable costs depend on the type of business that you have, however, these items increase and decrease according to your business activity. Hence, they fluctuate in relation to your sales.
For example, if you operate a restaurant or café, then your business’ food purchases would be dependent on the level of your sales. If sales for your food and coffee are low, then you would order less produce and your costs would be lower. If your restaurant or café is thriving, then you would obviously need to order a greater amount of produce to satisfy your customers’ demands, hence, your costs could be greater.
Knowing Your Break Even Point Is A Great Advantage
So, as you can see, it is a great advantage to know and what your business’ Break even Point is so you can identify if your business model is efficient & effective.
I see all too often business owners believing that they know what they’re doing with their costing and profit margins. However, I can tell you that every single time I sit down with a client who has profit issues within their business, the number one reason is due to them having absolutely no idea as to what their Break even Point is.
Most small business owners usually only take their direct costs into consideration. Again, to give you an idea, I will use the Restaurant or Café example.
But how could an owner of a Café or Restaurant operate a profitable establishment on the basis of charging their customers for their food and beverage products on only half the information? But this is what they do and they wonder why their business isn’t making any money!
In this situation, half of the information would be to only calculate your profit on how much you sell a cup of coffee for and only taking into consideration the cost of the coffee beans, milk and water.
So what about the electricity, the staff member’s salary and super who is actually making the coffee, your rent on the premises and all of your other costs that are associated with running a Restaurant or Café ?
However, ideally, every cost you have needs to be allocated in some proportion to that 1 cup of coffee that you’re selling.
So How Do We Find Your Break Even Point?
Although, I will happily tell you how to do this on your own, I would always advise that you see your accountant as this should be a walk in the park for them to ascertain this MAGIC number for you.
However, if you’re keen to give it a go yourself, see below for the couple of steps you will need to take –
So there are two steps to calculating your Break even point.
Step 1: Calculate your Contribution Margin
Your Contribution Margin is your Sales Price less your Variable Costs.
So, for example, if you’re business sells water bottles for $20 and your variable costs are $10 per water bottle. Then your contribution Margin pre water bottle would be the difference, which is $10 gross profit.
Step 2: Calculate your Break even Point
Total Fixed Costs divided by your Contribution Margin.
If your Total Fixed Costs add up to be $60,000 per year, then your Break even Point would be as follows.
$60,000 divided by $10 = 6,000 water bottles
What does this mean?
The above figure of 6,000 water bottles means that your business would need to sell 6,000 water bottles per year in order to cover all of your business’s operational costs (being both Fixed & Variable) for that year.
Finally, using this information, the business owner can then start to develop their sales budget. This along with their costing & marketing strategies, just to name a couple.
So give it a go and start implementing this tool to assist you in your business decisions.
Anyway, I hope that helps!