### Break-even analysis

The break-even point is the point at which your company makes enough money to cover its costs. Past this point, the company starts to make profit. Finding the break-even point through the analysis of costs is one of the most useful processes an entrepreneur can undertake. It helps you answer questions such as:

- What volume of sales do I need to break even?
- What profit can I expect from a particular volume of sales?
- What price should this product be sold at?
- Should advertising be increased or decreased?

### How to carry out a break-even analysis

**1. Separate your variable costs from your overheads**

Make a tally of all your costs separated by type â€“ either fixed or variable. If you come across a mixed cost, like a bill with a flexible usage fee and a flat subscription cost, work out which is the greater part and add it to the appropriate list. You want to finish knowing two things: your **total fixed costs** and the average variable cost of providing one product or service (known as the **variable cost per unit**). If you take away the variable cost per unit from your sales price, you have your **contribution (or profit) margin**.

**2. Now carry out the following calculation to find your break-even point**

**TOTAL FIXED COSTS Ã· CONTRIBUTION MARGIN = SALES VOLUME REQUIRED TO BREAK EVEN**

**Example:**

A window cleaner has fixed costs of $15,000, while the businessâ€™s variable costs average $15 per job and the charge out rate is $40 per job, so his contribution margin is $25. To break even he needs to carry out:

$15,000 Ã· $25 ($40 – $15) = 600 jobs

For a more honest estimate of viability, the business owner factors their own salary into the fixed costs part of the equation.

### Dollars

To obtain a dollar break-even point, you need to express the contribution margin as a decimal figure converted from a percentage. For example:

$25 = 62.5% of $40

62.5% = 0.625

Now simply divide the fixed costs by the contribution margin (decimal figure). So, our window cleanerâ€™s annual sales target to cover costs would therefore be:

$15,000 Ã· 0.625 = $24,000

### Hours

If your business is a service provider that charges an hourly rate, youâ€™ll want to know your hours-worked break-even point. Simply divide your fixed costs by your hourly call out rate. Say, for example, our window cleaner decided to charge $40 by the hour, after finding out a minority of jobs were taking up a lot of his time. His hours target to reach break-even would be:

$15,000 Ã· $40 = 375 HOURS

Again, in both cases, heâ€™d be wise to factor his salary expectations into his costs for a truer figure.

### Advertising spend

While break-even analysis is typically used to set a sales benchmark or estimate when a business will become profitable, it is also a fundamental tool when it comes to budgeting advertising dollars. Many businesses neglect to apply any analysis to advertising spend at all, especially if they are used to a set spending pattern every year. However, applying a break-even analysis to your advertising spend tells you exactly how effective that ad must be before the cost is paid for and it starts to help you make a profit.

The calculation is virtually identical to the standard equation â€“ just replace your fixed costs with the cost of the ad:

**ADVERTISING SPEND Ã· CONTRIBUTION MARGIN = SALES VOLUME REQUIRED FOR ADS TO BREAK EVEN**

**Example:**

The owner of a city garage and auto service shop is being offered a â€˜cut-priceâ€™ deal to advertise in a monthly car magazine â€“ a full page ad for $4,000. At the same time, he knows he sells a car service for $200, with the variable costs per service being $65. A break-even analysis would tell him he will need to carry out 29 extra services than usual during the month before he doesnâ€™t lose any money on the cost of the ad:

$4000 Ã· ($200 â€“ $65) = 29 services

### Weighted average price

Most companies make multiple products that cost varying amounts to make, yet their owners still need to know a single break-even point. To work this out, they multiply the price of each product by the average quantity they estimate to sell, before adding together a total of results, such as:

100 item X @ $2 | = | $300 |
---|---|---|

200 item Y @ $3 | = | $600 |

400 item Z @ $5 | = | $2,000 |

700 | $2,800 |

Dividing the total forecasted sales value by the total units they forecast to sell gives them a weighted average price = $4. This can then be used along with their weighted variable cost per unit (found using the same method) in a break-even equation.