When you enter a business, it is to make money, and it is also essential to know the break-even point. When this happens, your business will become profitable faster and remain in the black even if there is a downturn.
Knowing the revenue that needs to be generated will help you stay in the game and set a benchmark for your business. Evaluating a break-even point will also come in handy when diversifying the business.
A break-even analysis helps determine fixed and variable costs so you can set fair prices and forecast when your business will turn profitable.
Definition of Break-even Point For a Business:
A simple definition of the break-even point would be the stage at which you earn as much as you spend — no more, no less. To make it easy for you, we are sharing the break-even point formula:
Break-Even Point = Fixed Costs / (Average Price – Variable Cost)
Fixed Costs: These are more or less constant and include utilities, wages, and rent.
Variable Costs: These costs hinge on a business’s sales, including raw materials, transport, etc.
Average Price: This refers to the average cost of your products or services.
Going above and beyond the break-even point allows business owners to:
- Begin realizing profits.
- Experience growth and stability
Once you arrive at the number, evaluate all costs, including rent, raw materials, labor costs, and pricing structure. Next, place these questions before yourself. Are your prices sustainable? Can they get you to your break-even point within a reasonable time frame?
Steps for Reducing the Break Even Point
- Cut back on the fixed costs.
- Reduce the variable costs.
- Work on the product range.
- Tweak the selling price upwards with the sales holding steady.
You can also check this out A Guide To Risk Management In Startups
Advantages of a Break-Even Analysis
A break-even analysis presents the business with a lucid picture of its financial position. This allows making better decisions to avoid financial woes and maintain their longevity.
Additionally, the benefits of a break-even analysis include:
Plan Appropriate Pricing:
Finding your break-even point gives you an idea of how to price your product, which makes business sense and ensures profitability in the long run.
Support for Pricing Decisions:
A break-even analysis will aid in taking the guesswork out of pricing your products or services as it helps to base the decision on facts and hard numbers.
Helps Account for Expenses:
When you wish to arrive at your break-even point, taking into account all expenses pertaining to the business is necessary. Analyzing the break-even point in detail will help avoid any oversight when considering all related costs, no matter how trivial they appear.
Plan Revenue Targets:
A break-even analysis gives the business clear sales targets to work with. It also helps in aligning with the firm’s larger goals as well.
While on paper reducing the break-even point on paper may appear easy, the reality is quite different. Reducing variable costs would affect the firm’s production, while intense competition would prevent a price rise.
The decisions one makes rely on the market conditions and a deep study of the business cost structure to reduce the time it takes to reach the break-even point.