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By Alia Coster
efore launching a new business venture, it is important to calculate your break-even point (BEP) – this is when your revenue is equal to all your costs and is a key measurement for determining your start-up’s profitability.
“Break-even is important as it tells you how much you have to sell to cover all your outgoings, such as rent, salaries, etc. If you sell more than the break-even amount you are making a profit and if you sell less you are making a loss, which can’t be sustained long term,” explains Ian McLeish, Director of Rosslyn Associates, experts in accountancy and business planning.
By calculating your break-even point, you can then adjust your outgoings and sales targets to achieve break-even more quickly.
“In your business plan, you would normally include break even as the minimum to be achieved over a set period. Of course, you also want to include in your plan a calculation of the additional sales needed to achieve the profit you want.”
How do I calculate my BEP?
Every business is unique, and there will be a number of factors influencing your BEP, but you can get an idea by using one of these formulas (online BEP calculators can do the sums for you):
Fixed costs ÷ (Sales price per unit – Variable cost per unit) = BEP (in units) Fixed costs ÷ (Sales price – Variable costs) = BEP (sales in GBP)
Fixed cost: Rent, utilities, professional services, insurance; Sales price: How much you charge a customer for one of your products; Variable cost: How much it costs you to produce one of your products, including materials.
‘The first thing to disappear when you go into battle is your battle plan. You need to be flexible with your planning.’
How long will it take to get there?
Unfortunately, there is no simple calculation that can tell you how long it will take to break even, says McLeish: “Once your overheads are known and your break-even point calculated, then each month you will be able to see how far you are from break-even. If, say, you calculate that you need to sell 1,000 units to break even and in month one you sell 500 units, you know you are halfway to break-even.”
When exactly you break even will depend on how effective your sales and marketing is.
“Remember, if you decide to spend more on marketing or advertising, you will need to amend your break-even calculation to include the additional overheads,” adds McLeish. “In the above example, if you spend an additional £2,000 on advertising you will need to increase your break-even point by 200 units.”
“Of course, you might accept a loss for a few months in order to achieve break-even eventually, but the losses will need to be funded by, for instance, share capital investment or loans.”
Factors that will affect how soon you break even include the size of your initial start-up costs, the market demand for your product and services, and your pricing strategies (how much you mark up your product in comparison to your variable costs). You can use your calculation to see how adjusting any of these elements affects your BEP: play with different scenarios to get an idea of the best and worst cases.
Your break-even calculation might help you decide when you can afford to increase overheads too.
“If, say, an additional team member would cost £2,000 a month and you make £10 gross profit on each item sold, then you need to amend your break-even calculation to include an additional 200 sales per month (200 x £10 = £2,000),” adds McLeish.
What else do I need to know about my BEP?
Break-even is an important marker of profitability but it does have limitations, warns McLeish.
“The first thing to disappear when you go into battle is your battle plan,” McLeish explains. “You need to be flexible with your planning. When you prepare your break-even calculation, you have to make lots of assumptions. For instance, you can’t always predict what your suppliers will charge – there may be economic changes that make raw materials more expensive so that the cost of the items you sell increases. You then need to decide whether you can increase your prices too and recalculate your break-even point. If the profit is less, then you will need to sell more to achieve break-even.”
Similarly, your overhead (fixed) costs might increase – rent might go up, for example.
A break-even calculation is also not the same as a cash-flow statement. Your break-even calculation is a summary of sales and costs over a period – usually a year – broken down into monthly calculations.
“It takes no account of customers not paying, or the time it takes to pay suppliers, for instance,” says McLeish. “A start-up retail business might not notice much difference if payment is received from the customer at the time of sale and suppliers are paid in cash rather than credit.”
Any item in your calculation can change and your break-even calculation needs to be updated whenever a change takes place.
“As many assumptions have to be made when preparing a break-even calculation, it is best to err on the side of safety by including the highest probable amount for each cost item,” advises McLeish. “If it turns out that costs were less than you included, then if you hit your break-even target you will have made a profit. Similarly, if you fall short of your target you might still break even.”
Lead image: Cultura Creative RF / Alamy Stock Photo
How long it takes to break even depends on multiple factors, including your fixed and variable costs and pricing strategy. By calculating your BEP, you can adjust your targets to brak even more quickly.
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