To understand break even, you first need to know the components involved with business activity. But how do you find out what your business requires to break even?
What is break even in business?
Your business breaks even when your sales cover all your costs – when neither a profit nor a loss is made. To be able to work this out in more detail, there are numbers that you can analyse. These include ‘sales revenue’, ‘fixed and variable costs’, and the ‘contribution margin’.
Break even is the point where the total revenue generated equals the total cost incurred. To put it simply, this is achieved when all the money spent on production, marketing, distribution and administration is covered by the sales of the product. It is not uncommon for businesses to spend more than they earn, so knowing how much you need to sell to cover your expenses is crucial.
Why break even is important
Knowing and understanding your break-even point gives you better insight into your business, accountability and enables you to make important business decisions that will improve your profit margins and company success. You can pat yourself on the back when reaching that financial milestone!
The key to break even is to work out the contribution made from the sale of each unit.
The amount of cash each unit has sold is an offering towards paying for the fixed and variable or indirect costs of the business.
Types of costs
Fixed costs are representative of your business costs that build up with the passage of time. They do not increase and should remain predominantly constant regardless of the activity level (miles traveled, journeys made). Hence, the cost of car road tax will be the same whether it is driven 100 miles a year or 10,000 miles a year (the same applies to insurance & MOTs).
Other fixed costs include: rents and rates, depreciation on assets or leasing charges.
The second type of costs that are part of the break even equation are variable costs. They will directly vary according to the production volume and change directly when the volume production changes. So, these costs vary with changes in level of activity. For a car, a variable cost would be petrol. Likewise, the total petrol cost will vary according to how many miles we do. Other examples of variable costs are stocks (will vary according to level of sales), sales commissions (as before) and overtime (this will vary according to number of hours worked).
Reducing your fixed costs base provides you a better gross profit. After you’re able to make reductions, however small or large, you will ultimately have a nice amount of return (which makes it easier to break even).
It is completely understandable why you may be reluctant to get closer to your numbers. They can be a little scary. However, if you want to run a successful business instead of a hobby then you need to have those down. Along with your targets these two are must have for success.
You don’t need a degree in Accountancy or Maths to be part of the winning team. You need two numbers to break even – fixed costs & profit margins. Check out our free online break-even calculator – a very useful tool to get you started towards figuring out your break even.
And remember, calculating it is one thing and knowing what to do with it is another.
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