Break-even analysis identifies the point at which your business starts to make a profit. You can work out the break-even point using any timescale, eg weekly, monthly, yearly, etc.
To calculate the break-even point you need to know the following:
- the total fixed costs of your business - these include rent and rates, your drawings, loan repayments, etc;
- the total variable costs for producing your product - these include labour, materials and packaging; and
- the selling price of your product.
Once you have these figures, you can work out your break-even point using four simple calculations and plotting the findings on a graph.
Ron from Widgets 'R' Us wants to work out how many widgets he needs to sell in order to break-even every month. He works his fixed costs out as follows:
- Rent - £167 per month
- Salary - £834 per month
- Rates - £70 per month
- Loan repayment - £100 per month
- Total - £1,171
(Note: It is better to round figures up rather than down as this will increase your safety margin.)
This figure can be plotted as follows:
Ron then works out his variable costs for the production of each widget:
- Materials - £9.00
- Packaging - £1.00
- Labour - £11.00
- Total cost - £21.00 per widget
He selects a value on the 'number of widgets' axis (in this case, 250) and does the following calculation:
- 250 widgets x £21.00 per widget = £5,250
Ron plots this figure on the graph and draws a straight line from it to zero.
The next step is for Ron to work out his total costs. To do this, he adds his fixed costs to his variable costs:
He plots this figure on the graph and draws a straight line from it to £1,171 on the 'Pounds' axis.
Ron now needs to work out his revenue line. To do this, he simply multiplies his products' selling price by the example number of widgets he chose earlier (250):
He then plots this figure on the graph and draws a straight line from it to zero.
Ron can now find his break-even point simply by locating the exact point where the revenue line disects the total costs line.
In this case, Ron must sell 100 widgets each month if his business is to break-even. If he sells more than 100, he makes a profit; if he sells less he makes a loss.