Understanding your break-even point is crucial for making sound business decisions.
To keep your business running smoothly, you need to sell enough products or services to reach this point. Knowing where it lies, and how long it might take to get there, can be critical for your success—especially if you’re planning to start or purchase a business.
Calculate Fixed and Variable Costs
The first step is to identify your fixed and variable costs.
Fixed Costs
Fixed costs, also known as overheads, are expenses your business must pay regardless of sales levels. Common fixed costs include:
- Salaries for permanent staff
- Rent for your premises
- Insurance
- Interest on loans
Variable Costs
Variable costs fluctuate with sales volume. Examples include production materials, sales bonuses, part-time wages, and delivery charges.
Calculate:
- Total fixed costs for the year.
- Average variable cost per unit for each product or service sold.
Some bills may combine fixed and variable components, like a phone bill with both a line rental and call charges. For accuracy, try to split these bills into fixed and variable portions. If that’s not practical, classify the bill based on its larger component. For instance, if your call charges are low, you might treat the phone bill as a fixed cost.
Determine Your Break-Even Point
Imagine you’re a shoe manufacturer with the following details:
- Fixed costs budgeted at £60,000
- Average cost to produce a pair of shoes: £110
- Average sale price per pair: £250
To calculate your break-even point, use these formulas:
- Sales Price per Unit (£250) – Variable Cost per Unit (£110) = Contribution Margin per Unit (£140)
- Contribution Margin per Unit (£140) ÷ Sales Price per Unit (£250) = Contribution Margin Ratio (0.56)
- Fixed Costs (£60,000) ÷ Contribution Margin Ratio (0.56) = Break-even Sales Volume (£107,142)
In this example, to break even, you’d need to sell over £107,142 worth of shoes, or 429 pairs. Selling beyond this would result in profit.
Using Your Break-Even Point
Once you know your break-even point, the next step is to assess if reaching that sales volume is realistic.
Your break-even calculation also enables you to explore the impact of cost changes. For example, sourcing cheaper materials could reduce your variable cost per unit, meaning you’d need to sell fewer shoes to break even. Alternatively, if sales remain stable, this reduction would increase your profit.
Accurate break-even calculations depend on precise fixed and variable costs. Inaccurate figures will lead to misleading results, so invest time in calculating your costs carefully.
With these steps, you’ll be in a strong position to make informed decisions and guide your business towards profitability.
Looking for a Fulham accountant to help you manage your business finances? Reach out to our team today to get started – we’d love to help.
e: office@londonaccountants.co t: 0203 137 9791
Kind Regards,
The Team at London Accountants
