Is your business going to make enough money to cover all your expenses?
Before you begin to cringe at the thought… This is the question a break-even analysis can answer for you.
Whether you’ve already started a company of your own or you’re now in the process of starting a business, there’s one thing you need to understand:
Before investing any money into your business you need to have a clear understanding of your break-even point.
Let’s see why a break-even analysis can benefit your business and, of course, find out how to do it.
The break-even point
The break-even point is just jargon for pressing questions like:
- Are we going to make money?
- Are we going to break even?
- Are we going to make enough money in order to pay all our expenses?
In order to be able to answer these questions, you need to make some calculations or a break-even analysis.
Your break-even analysis helps you understand specifically what your fixed and variable costs are going to be.
What are fixed costs?
I will illustrate fixed costs with an example. Let’s say I set up a store at the market this weekend. They charge me $100 for one day rent.
Let me ask you this, if I sold 1 or 20 hot dogs, how much would my fixed cost be? $100, right?
It is a fixed cost no matter how many hot dogs I end up selling that day. Therefore, I need to sell enough hot dogs in order to make enough money to pay the rent.
That is my fixed cost.
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What are variable costs?
Variable costs are the costs you have to cover every time you make a sale.
Let’s go back to our example. If I sold 0 hot dogs it hasn’t cost me anything, right? Hypothetically, I haven’t sold any buns or sausages.
Now, you may be saying, “Andrew, you already bought all those buns and sausages.”
Yes, I did. That’s a really good point.
But can you just work with me for a moment here? Just put that observation to the side and let’s assume that I haven’t sold anything. So it hasn’t cost me anything.
[ctt template=”7″ link=”6l0z5″ via=”yes” ]Variable costs are correlated to what we sell.[/ctt]
How does a break-even analysis look like?
Let’s make a break-even analysis on my small business.
I sell a hot dog for $2: the bun costs 50 cents and the sausage 50 cents. This means, when I sell one hot dog, my variable costs are $1.
Let’s say I sell 100 hot dogs that day.
100 hot dogs for $2 each makes a total of $200.
The numbers look like this:
- sales = $200
- cost = $100
- …which leaves me with $100 profit
Before I get too excited about my $100 profit, let’s go back to that fixed cost we discussed earlier.
Remember that fixed cost? The rent? The $100 now has to cover the rent.
I know we haven’t even worked out my time, the cost of electricity or any of those things.
With the aim to keep it as simple as clear as possible, this is what a break-even analysis looks like:
- I need to sell 100 hot dogs for $2 to cover $100 in variable costs and $100 in fixed costs
- If I sell 100, I break even. Made no money loss and no money.
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I can assist you in making the right decisions when it comes to your business. Whether you have questions about accounting software or company set up, I am here to help. Let’s get in touch now.