Adobe Reader
a free program to read PDF (Portable Document Format) files.
In The News
February 2011: Calculating and using the break-even point by Andrea Testi
In business, there are a few key numbers that managers will constantly monitor in order to keep their companies running smoothly. Sometimes managers will calculate the life-time value of a customer to keep a good perspective on customer service, while others might monitor the profit and turn rate per inventory item to maximize their merchandising efforts. While each industry has its own unique set of key numbers to monitor, one of the most widely used indicators is the break-even point. The break-even point is the level of sales at which a business neither makes a profit nor sustains a loss; the point at which the business has exactly enough income to cover expenses, with nothing left over.
The steps involved in calculating the break-even point include the following:
1. Compile a list of all business expenses.
2. Separate the list into variable and fixed expenses, and then add them up. (Variable expenses change proportionately to a change in sales or production; fixed expenses do not change in proportion to sales or production.)
3. Subtract the per unit variable cost from the sales price to obtain a per unit contribution margin.
4. Divide fixed expenses by this contribution margin. This answer is the break-even point in unit sales.
Let’s try an example. A feed store compiles a list of all business expenses and has found that they need $15,000 per month to cover the fixed costs of rent, salaries, insurance, etc. They also buy feed at a wholesale price of $1.50 per pound and sell it for $2.00 dollars per pound. To calculate the break-even point, subtract the $1.50 per pound cost from the selling price of $2.00 dollars per pound and you’ll get a 50 cent per pound gross profit margin. Divide the 50 cents per pound into the $15,000 monthly fixed costs, and the store will need to sell 30,000 pounds of feed each month to pay its expenses. That’s an average of 1,000 pounds in sales per day!
What’s interesting are the sales beyond the break-even point. This is where profit occurs. With the feed store example, $60,000 worth of feed must be sold in order to pay all monthly bills without any profit. Now, every single additional dollar of sales past this point, contributes 50 cents to profit. Where sales of 30,000 pounds of feed showed no profit, sales of 35,000 pounds nets a $2,500 profit.
Knowing that profit doesn’t occur until after the break-even point is reached highlights the power of achieving the break-even point as early in the month as you can. The sooner you achieve this point, the sooner you start making profit. It also shows the importance of keeping your fixed costs down. The smaller your costs, the quicker you’ll achieve break-even.
The team at the TVCC BizCenter can help you apply the break-even method to your business. It is a good tool for an initial analysis of problems involving costs and sales relationships, and to demonstrate how much additional revenue would be required to take on more expenses. Call Deb at (541) 881-5762 to schedule your appointment to meet with Michael, BizCenter financial adviser.
Andrea Testi is the Treasure Valley Community College Small Business Development Center director. She can be contacted at atesti@tvcc.cc.
