Breakeven analysis is an important and useful tool in business. Whether starting a new business, expanding current operations, contemplating an acquisition, downsizing, or approaching banks and other potential lenders, one should know what the breakeven is.
Breakeven is simply the point at which costs equal income – no profit, no loss. It’s an excellent starting point for finding out where the business is and where it can go. It’s the first step in planning future growth. It shows how much sales volume is needed to cover fixed and variable expenses. Once a company has reached breakeven, all gross profit beyond that point goes directly to improving the bottom line.
There are certain limitations for the use of breakeven analysis. It ignores the importance of cash flow and makes the assumption that fixed and variable expenses will stay within the parameters used to calculate the breakeven. Sound business assessment will overcome these shortcomings.
- Calculating breakeven
Breakeven is relatively easy to understand and use. First, review the annual financial statement in order to figure out fixed and variable expenses. Fixed expenses are those that don’t generally vary in relation to sales volume. Rent, for example, usually stays constant, whether sales are $400,000 or $500,000. The same is generally true for depreciation, utilities, insurance, and so on.
Variable expenses are the cost of goods sold and other costs of sales, such as direct labor and sales commissions.
There are, of course, some costs that are, or seem to be, part fixed and part variable. One must use good business judgment to split these items into reasonable proportions.
Knowing selling price and variable costs allows you to compute gross profit percentage. The rest is pure arithmetic. Divide your fixed costs by your gross profit percentage to arrive at breakeven. For example, if you have fixed costs of $10,000 and your gross profit percentage is 25%, your breakeven point is sales of $40,000 ($10,000 ÷ 25% = $40,000).
Call us; we would be happy to assist you with calculating your business’s breakeven point and evaluating your profit structure.