Business Breakeven Analysis Article

The Breakeven Analysis – The Importance of Knowing Your Company’s Breakeven

We all know that the Breakeven Point in a business is when it’s not making a profit or losing money. Sounds simple, right? Well, can you tell me what your exact Breakeven Point is? Probably not. Most business owners either don’t know it or think they know it, with neither exactly knowing. Breakeven can be expressed as a Dollar amount or Unit Sales, and once determined, you have a Target to reach through a carefully thought out Business Plan. Without an established Breakeven Target, your Strategic Plan is floundering.

It is very important to understand that increased Sales do not always translate into increased Profits. Many companies have gone out of business by ignoring the importance of Breakeven Analysis, thinking increased Sales will lead to certain Profitability. Unfortunately, more often than not, the company’s Variable Costs, or those directly derived from sales levels, get exponentially larger as Sales Volume Grows. Not knowing the Variable Costs is a silent killer for many companies.

When calculating the Breakeven Point, you will have to make certain assumptions and estimates. Error on the side of conservative numbers by using more pessimistic sales and margin thresholds, while overstating your projected costs. You want the Breakeven Point to be in the safe zone – a worst case threshold.

Breakeven Formula: S = FC + VC

S = Breakeven point of sales in dollars

FC = Fixed Costs in dollars

VC- Variable Costs in dollars

Fixed Costs

Costs that remain mostly constant despite what the Sales Volume may be. Fixed Costs remain constant in a certain range, after which they change, particularly, after a steep increase in Sales (i.e. you need a bigger building or more employees). It is important to understand that these costs must be paid no matter whether the company makes sales or not.

Fixed Costs include:

• Overhead Costs: Rent, Office / Administrative Costs, Salaries, Benefits, FICA and so forth.
• Interest Charges: For Term Loans and Mortgages.
• Hidden Costs: Depreciation, Amortization and Interest.

Variable Costs

Costs directly associated with the Sales level and include:

• Costs of Goods Sold
• Variable Labor Costs
• Sales Commissions

When you don’t know what your Variable Costs will be, you can use a variation on the Breakeven Formula, provided you know what your Gross Margin will be as a percent of Sales:

S = FC ÷ [1- (Variable Expenses**) ÷ Sales]

** = VE include Material Costs, Variable Operating Expenses and Variable Labor.

To get Breakeven in Units Sold, divide the Breakeven Dollar Amount by the Unit Price.

Why is the Breakeven Analysis Important?

• You can plan ahead and determine the amount of finance needed to grow the company.
• By graphing the Breakeven Analysis pictorially, it is much easier to make the Strategic Objectives more tangible and achievable.
• You can use the Breakeven Formula to measure your Company’s progress toward Profit Goals. It is a great tracking tool when graphed pictorially and can work in conjunction with your Strategic Plan’s Milestone Goals.
• Understanding what your Breakeven Point is when setting Profit Goals through the formula:
  S = FC ÷ [1- ((Cost of Sales + Variable Operating Expenses) ÷ Sales)]
• Breakeven Charts help your employees visualize your Company’s progress toward profit goals.
• Once you know your Breakeven Sales level, then you can break that Sales Level down into the amount of Customers required.
• Plug in three Sales Values (Best, Worst Case and Most Probable) to determine when your Fixed Costs will be covered. This is invaluable when planning your Finance Requirements.
• Breakeven Analysis is an excellent process to determine the effect of different unit costs for expected sales for each unit type. Understanding which your most profitable units are, and how they relate to Breakeven and Profit Goals is the heart of your Marketing Strategy and Strategic / Sales Plan.

If Breakeven Analysis is used as a tool to realistically understand Profit Projections and Profit Analysis, it is extremely effective. A Business Owner’s and his/her Employees knowing on a daily basis what it takes to breakeven for the month, quarter or the applicable period of times is a powerful tool in realizing a Company’s Profit Goals. Moreover, Breakeven Analysis is directly affected by a Company’s Marketing Plan and vice versa. The Company Strategic & Sales Plan is a realization of the breakeven Analysis. When you think of it this way, Breakeven Analysis is at the core of the planning and analysis necessary for Business Success. It is a great tool, only if you use it!