It’s very likely that you know the necessity of writing a business plan, particularly if you plan to seek funding. One key component of any such plan, especially one pitched to investors, is a break-even analysis. While this type of analysis involves some math, numbers and formulas, it is often not as difficult and overwhelming as folks might think once they get started. Because a break-even analysis helps you figure out your costs and profit forecast, it really is important. Here’s the lowdown on how to write a break-even analysis.
One huge factor that governs your expenses and profits is the market of your business. To that end, your initial focus in writing a break-even analysis should be the market of your business at that point in time. You’ll need to estimate the following items:
- Business overhead: This section focuses on expenses that are stable for the most part. This is where you list rent, utilities, insurance, vehicle loan payments and the like.
- Sales revenue: This is the section where you need to get extremely realistic. You may have an ideal figure for how much volume your business will be involved in to turn a profit, but the figure might not be practical or realistic. Many new businesses are not profitable for their first few years. Focus this analysis on what is realistic rather than ideal earnings. To be safe, shoot for the low end of the volume you expect, and calculate the total monetary proceeds from your sales on both a monthly and yearly basis.
- Average gross profit: Average gross profit is your profit after you subtract direct costs from each sale. For example, if a bicycle costs you $30 to sell, and you are selling it for $60, your average gross profit amounts to $30.
- Average gross profit percentages: These percentages calculate the percentage of each dollar of sales income that can be counted as gross profit. In other words, if you earn an average profit of $30 on each $30 bicycle that you sell for $60, your average gross profit percentage is 50 percent.
Calculating the Break-Even Point
Thanks to your hard work in figuring out the numbers above, you need only to divide your yearly overhead by your average gross profit percentage to calculate the break-even point of your business. The resulting number is how much sales revenue your business needs to break even.
To give an example, say that your annual overhead is $7,000, and your average gross profit percentage is 50 percent. 7000/.50 results in a break-even amount of $14,000 a month. Here are a few key points to keep in mind:
- The break-even point considers sales revenue.
- It does not calculate other factors such as salary.
- It does not focus on profit.
- Your break-even point is the amount of money you need monthly to pay overhead and costs directly related to sales.
The break-even point is simply the point at which you break even with your revenue and overhead.
At this point in the process, the usefulness of a break-even analysis becomes apparent to many business owners. Their number is too high, too overwhelming. However, there is no need to panic. You can try to bring costs down, and perform another break-even analysis after that. Many startup businesses skimp in certain areas that they would rather not, but as they get rolling later on, they are able to focus more fully on these aspects. The completion of such an analysis is a good time to identify the areas where you can cut back. Examples include working from home or finding a less expensive place to rent, boosting sales prices, taking on more work yourself rather than hiring someone part time, and purchasing fewer supplies or supplies that cost less.
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