Understanding The Three Elements Of Break Even
Making the decision to start your own business is a bold move that involves risk but can also come with greater rewards. As a potential entrepreneur you need to conduct your market research in order to estimate the size of the potential market, competition and potential sales, as these are some of the factors that will determine your business’ success.
Being a new business, your company might not generate expected income in the initial stage but can make enough that you are not making a loss or a profit. At this point your business can still survive however this might not be a good position in the long run.
What is the Break-even point
The Break-even point is when your company balances its total costs with total sales or when total cash inflows equal total cash outflows. At this point your business is not making a loss or a profit.
To understand the break-even analysis, we must first define the components of the Break-even calculation;
- Fixed Costs: Expenses that do not change as sales change, for example Rent.
- Variable Costs: Expenses change as sales levels change (the more products sold, the more the cost for example, ).
- Cash inflows: price per unit.
Your break-even point is equal to your fixed costs, divided by your average price, minus variable costs.
Break-Even Point = Fixed Costs/(Average Price — Variable Costs)
Benefits of knowing the Break-even point
- Knowing your break-even point will help business owners to calculate, for example, how many units of a product that need to be sold in order to reach break-even.
- You can be in a better position to set SMART sales or revenue targets for their sales teams.
- You can also evaluate and analyse the fixed and variable costs and how they affect profitability (high costs reduce profits)
- Know your break even point allows you to make better pricing decisions for your business.
- Access to funding is also easier because break-even-analysis is part of the requirements of any business plan.
At Tradies Accountant, we can help you do your break-even analysis and business performance reviews quarterly. Book a meeting for a free initial review of your business today.