How To Do A Break Even Analysis
by Tom Egelhoff
The following article on break-even analysis is from my book, "How To Market, Advertise And Promote Your Business or Service In A Small Town".
When you have your costs under control you need to consider a break even analysis for each product or service you provide. The break even analysis assumes that average variable costs are going to remain constant for each product or service. This analysis is strictly internal. It doesn't consider things like competition or market demand.
Fixed Costs & Variable Costs
Fixed costs are things like the rent or equipment leases. Variable costs might be monthly shipping charges, cost of supplies, sales commissions; any expense that changes from month to month. If you aren't sure which they are, consider them fixed. Remember other things like insurance, maintenance, payroll, utilities, automobile, and advertising costs to name just a few.
What's The Formula?
Are you sure you're ready for this? OK, stay with me here. Total profit equals the number of units sold multiplied by the selling price less the number of units sold multiplied by the total variable cost minus the total fixed cost. Pretty simple, huh? If capital P is profit, small p is price, U is units sold, V is variable costs and F is fixed costs the equation would look like this:
So, assume we have a product we want to sell for $10.00 and we want to sell 1,000 of them. For this example our total fixed costs are going to be $7,700 and our total variable costs are $4.50/unit. Our formula would look like this:
P=1,000($10.00-$4.50)-$7,700=$5,500-$7,700 = - $2,200
Instead of making money we have just lost $2,200. At break even the $2,200 number should be $0. We can't make money at 1000 units so how many must we really sell to break even?
We know our fixed costs (F) are $7700, and the price (p) is still $10.00 and our variable costs (V) are $4.50/unit we do this:
(p) price minus (V) variable costs divided into (F) fixed costs or
$10.00 - $4.50 = $5.50 divided into $7700 = 1400 units.
If we maintain our price and expenses we need to sell 1400 units of our product to break even. If we raise our price or reduce expenses we can sell less.
The Last Word On Breaking Even
Some points to remember. The break even analysis does not show profitability. It will show some levels of profit at various levels of sales but sometimes profits must be thrown at company problems. Even though a product breaks even (or makes a profit) if all other goods and services don't, you could be in trouble.
This is a guide to get you started. Good accountants are worth their weight in gold. Take this basic information to them and have them tailor it to your business.
Once you have the information as to how much it will cost to keep the doors open and the business viable we can move on to the next part of the marketing plan.
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Based in Bozeman, MT, Tom Egelhoff is the author of How To Market, Advertise & Promote Your Business Or Service In A Small Town, and The Small Town Advertising Handbook: How To Say More And Spend Less. He is also a seminar and workshop presenter and trainer. He may be reached at 888-550-6100 or PO Box 271, Bozeman, MT 59771-0271
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