Turning a profit is the main goal of any business. However, for small- to medium-sized businesses (SMEs), it’s especially crucial. Oftentimes, these companies have minimal start-up capital, so turning a quick profit is a necessity for the doors to stay open. So, in these early days, how can you tell if and when you’ll be profitable? You use a break even analysis, which works out and determines the break even point of units required to sell to cover your businesses start up and running costs.
Determine Your Costs
The first step of a break even analysis is relatively simple: You determine your total costs. These include your fixed costs and your variable costs.
Fixed costs are incurred whether you sell any products or not. These include your overhead costs, such as your rent, utilities, insurance and office staff salaries.
Variable costs are only incurred when you’re making sales. If you sell products, variable costs will include the labor and materials required to make those products. If you sell services, variable costs include anything required to perform that service, such as fuel, job materials and so on.
Find Your Products Price
Once you have your estimated costs, it’s time to determine the best starting price for your products or services. There are two basic types of pricing.
Cost-based pricing uses your variable costs as the starting point for determining the best price. For example, if you want each product to generate a contribution margin ratio of 30 percent, you will take the variable costs of that product and multiply by 1.3 to find your price. This is used for most businesses.
Value-based pricing essentially does the opposite. With this model, you determine a price based on the value you’re offering to customers, then you try to budget your costs so you turn a profit based on this price. Businesses that offer a unique product or service often use value-based pricing.
The Break Even Formula
Once you’ve determined your costs and your price, you can plug those numbers into the following formula to determine your break-even point:
Break even Point = Fixed Costs / (Price Per Unit – Variable Costs Per Unit)
Once you determine your break even point, you can decide whether your business will be profitable. If you need to sell 1,000 units of your product to break even, you’ll need to decide whether you think that’s possible or not. If you need to turn a profit quickly, you’ll need to take that into consideration when you use the break even formula. As you’re doing this analysis, remember that sales aren’t the same as cash flow. You may have strong sales with slow cash flow. To increase your cash flow, contact us IntegraPay about our payment solutions. At IntegraPay we can assist with your cash flow by way of direct debit, credit card on a recurring or one-off basis.
Download Our Free Break Even Analysis Template
At IntegraPay we’ve put together a simple excel spreadsheet which will assist you working out your cost-based pricing and the break even analysis. Simple list your fixed costs & amounts in the left column & all your variable costs in the right column. You can then list your products cost, qty and the margin you want to add on to your costs. This will then calculate your markup, the products final RRP price as well as the products total revenue ceiling. From these costs it will then give you the average price per unit, the total contribution margin and the total number of units that will need to be sold in order to break even. This analysis template does not take into account or factor in GST and is to only be used as a general guide and does not warrant any guarantees.