How to Do a Breakeven Analysis

If you can accurately forecast your costs and sales, conducting a breakeven analysis is a matter of simple math. A company has broken even when its total sales or revenues equal its total expenses. At the breakeven point, no profit has been made, nor have any losses been incurred. This calculation is critical for any business owner, because the breakeven point is the lower limit of profit when determining margins. Defining Costs There are several types of costs to consider when conducting a breakeven analysis, so heres a refresher on the most relevant.

Fixed costs: These are costs that are the same regardless of how many items you sell. All start-up costs, such as rent, insurance and computers, are considered fixed costs since you have to make these outlays before you sell your first item. Variable costs: These are recurring costs that you absorb with each unit you sell. For example, if you were operating a greeting card store where you had to buy greeting cards from a stationary company for $1 each, then that dollar represents a variable cost. As your business and sales grow, you can begin appropriating labor and other items as variable costs if it makes sense for your industry. Setting a Price This is critical to your breakeven analysis; you cant calculate likely revenues if you dont know what the unit price will be. Unit price refers to the amount you plan to charge customers to buy a single unit of your product.

Psychology of Pricing: Pricing can involve a complicated decision-making process on the part of the consumer, and there is plenty of research on the marketing and psychology of how consumers perceive price. Take the time to review articles on pricing strategyand the psychology of pricing before choosing how to price your product or service. Pricing Methods: There are several different schools of thought on how to treat price when conducting a breakeven analysis. It is a mix of quantitative and qualitative factors. If youve created a brand new, unique product, you should be able to charge a premium price, but if youre entering a competitive industry, youll have to keep the price in line with the going rate or perhaps even offer a discount to get customers to switch to your company. One common strategy is "cost-based pricing", which calls for figuring out how much it will cost to produce one unit of an item and setting the price to that amount plus a predetermined profit margin. This approach is frowned upon since it allows competitors who can make the product for less than you to easily undercut you on price. Another method, referred to by David G. Bakken of Harris Interactive as "price-based costing"encourages business owners to "start with the price that consumers are willing to pay (when they have competitive alternatives) and whittle down costs to meet that price." That way if you encounter new competition, you can lower your price and still turn a profit. This presentation from Harris Interactive offers a further explanation of these methods, and About.com offers an overview of common pricing methods. The formula: Dont worry, its fairly simple. To conduct your breakeven analysis, take your fixed costs, divided by your price, minus your variable costs. As an equation, this is defined as: Breakeven Point = Fixed Costs/(Unit Selling Price - Variable Costs) This calculation will let you know how many units of a product youll need to sell to break even. Once youve reached that point, youve recovered all costs associated with producing your product (both variable and fixed). Above the breakeven point, every additional unit sold increases profit by the amount of the unit contribution margin, which is defined as the amount each unit contributes to covering fixed costs and increasing profits. As an equation, this is defined as: Unit Contribution Margin = Sales Price - Variable Costs Recording this information in a spreadsheet will allow you to easily make adjustments as costs change over time, as well as play with different price options and easily calculate the resulting breakeven point. You could use a program such as Excels Goal Seek, if you wanted to give yourself a goal of a certain profit, say $1 million, and then work backwards to see how many units you would need to sell to hit that number. (This online tutorial will show you how to use Goal Seek.) Calculators There are several online calculators to assist you with your breakeven analysis:

Case Western Reserve University offers a breakeven analysis calculator that includes a review of relevant microeconomic terms. This financial calculator allows you to chart your costs and profits appear in a graph. Inc.com offers a breakeven analysis calculator that requires a user to enter in total annual overhead and annual year-to-date sales and cost of sales, and lets the user delineate the period for the YTD calculations in terms of weeks. Limitations It is important to understand what the results of your breakeven analysis are telling you. If, for example, the calculation reports that you would break even when you sold your 500th unit, decide whether this seems feasible. If you dont think you can sell 500 units within a reasonable period of time (dictated by your financial situation, patience and personal expectations), then this may not be the right business for you to go into. If you think 500 units is possible but would take a while, try lowering your price and calculating and analyzing the new breakeven point. Alternatively, take a look at your costs both fixed and variable and identify areas where you might be able to make cuts. Lastly, understand that breakeven analysis is not a predictor of demand, so if you go into market with the wrong product or the wrong price, it may be tough to ever hit the breakeven point.

What is Break even point? Define in details?

The Break-even Point is, in general, the point at which the gains equal the losses. A break-even point defines when an investment will generate a positive return. The point where sales or revenues equal expenses. Or also the point where total costs equal total revenues. There is no profit made or loss incurred at the break-even point. This is important for anyone that manages a business, since the breakeven point is the lower limit of profit when prices are set and margins are determined. Achieving Break-even today does not return the losses occurred in the past. Also it does not build up a reserve for future losses. And finally it does not provide a return on your investment (the reward for exposure to risk). The Break-even method can be applied to a product, an investment, or the entire company's operations and is also used in the options world. In options, the Break-even Point is the market price that a stock must reach for option buyers to avoid a loss if they exercise. For a Call, it is the strike price plus the premium paid. For a Put, it is the strike price minus the premium paid. The relationship between fixed costs, variable costs and returns Break-even analysis is a useful tool to study the relationship between fixed costs, variable costs and returns. The Break-even Point defines when an investment will generate a positive return. It can be viewed graphically or with simple mathematics. Break-even analysis calculates the volume of production at a given price necessary to cover all costs. Break-even price analysis calculates the price necessary at a given level of production to cover all costs. To explain how break-even analysis works, it is necessary to define the cost items. Fixed costs, which are incurred after the decision to enter into a business activity is made, are not directly related to the level of production. Fixed costs include, but are not limited to, depreciation on equipment, interest costs, taxes and general overhead expenses. Total fixed costs are the sum of the fixed costs. Variable costs change in direct relation to volume of output. They may include cost of goods sold or production expenses, such as labor and electricity costs, feed, fuel, veterinary, irrigation and other expenses directly related to the production of a commodity or investment in a capital asset. Total variable costs (TVC) are the sum of the variable costs for the specified level of production or output. Average variable costs are the variable costs per unit of output or of TVC divided by units of output. The Break-even Point analysis must not be mistaken for the Payback Period, the time it takes to recover

an investment. In Value Based Management terms, a break-even point should be defined as the Operating Profit margin level at which the business / investment is earning exactly the minimum acceptable Rate of Return, that is, its total cost of capital. Break-even Point calculation Calculation of the BEP can be done using the following formula: BEP = TFC / (SUP - VCUP) where: BEP = break-even point (units of production) TFC = total fixed costs, VCUP = variable costs per unit of production, SUP = selling price per unit of production. Benefits of Break-even Analysis The main advantage of break-even analysis is that it explains the relationship between cost, production volume and returns. It can be extended to show how changes in fixed cost-variable cost relationships, in commodity prices, or in revenues, will affect profit levels and break-even points. Break-even analysis is most useful when used with partial budgeting or capital budgeting techniques. The major benefit to using break-even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.