Break-even Analysis 17

The Break-even Analysis lets you determine what you need to sell, monthly or annually, to cover your costs of doing business—your break-even point. Illustration 1 shows the Break-even Analysis table:

Illustration 1: Break-even analysis
Break Even Analysis Chart

The Break-even Analysis table calculates a break-even point based on fixed costs, variable costs per unit of sales, and revenue per unit of sales.

Understanding break-even analysis

The break-even analysis is not our favorite analysis because:

  • It is frequently mistaken for the payback period, the time it takes to recover an investment. There are variations on break even that make some people think we have it wrong. The one we do use is the most common, the most universally accepted, but not the only one possible.
  • It depends on the concept of fixed costs, a hard idea to swallow. Technically, a break-even analysis defines fixed costs as those costs that would continue even if you went broke. Instead, you may want to use your regular running fixed costs, including payroll and normal expenses. This will give you a better insight on financial realities. We call that “burn rate” these post-Internet days.
  • It depends on averaging your per-unit variable cost and per-unit revenue over the whole business.

However, whether we like it or not, this table is a mainstay of financial analysis. You may choose to leave it out, but really, a business plan would not be complete without it. And, although there are some other ways to do a Break-even Analysis, this is the most standard.

The Break-even Analysis depends on three key assumptions:

  1. Average per-unit sales price (per-unit revenue):
    This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get this number from your Sales Forecast. For non-unit based businesses, make the per-unit revenue $1 and enter your costs as a percent of a dollar. The most common questions about this input relate to averaging many different products into a single estimate. The analysis requires a single number, and if you build your Sales Forecast first, then you will have this number. You are not alone in this, the vast majority of businesses sell more than one item, and have to average for their Break-even Analysis.
  2. Average per-unit cost:
    This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per dollar of revenue or unit of service delivered, to deliver that service. If you are using a Units-Based Sales Forecast table (for manufacturing and mixed business types), you can project unit costs from the Sales Forecast table. If you are using the basic Sales Forecast table for retail, service and distribution businesses, use a percentage estimate, e.g., a retail store running a 50% margin would have a per-unit cost of .5, and a per-unit revenue of 1.
  3. Monthly fixed costs:
    Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke. Instead, we recommend that you use your regular running fixed costs, including payroll and normal expenses (total monthly Operating Expenses). This will give you a better insight on financial realities. If averaging and estimating is difficult, use your Profit and Loss table to calculate a working fixed cost estimate—it will be a rough estimate, but it will provide a useful input for a conservative Break-even Analysis.

Illustration 2 shows a Break-even chart. As sales increase, the profit line passes through the zero or break-even line at the break-even point.

Illustration 2: Break-even chart
Break Even Graph
Click to Enlarge Graphic

The illustration shows that the company needs to sell approximately 1,222 units in order to cross the break-even line. This is a classic business chart that helps you consider your bottom-line financial realities. Can you sell enough to make your break-even volume?

The break-even analysis depends on assumptions made for average per-unit revenue, average per-unit cost, and fixed costs. These are rarely exact. We recommend that you do the break-even table twice: first, with educated guesses for assumptions, as part of the initial assessment, and later on, using your detailed Sales Forecast and Profit and Loss numbers. Both are valid uses.

About the Author Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry. Follow Tim on Google+ Read more »

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  • Anand

    Hi Bplan,pls suggest how to plan a start up wholesale distribution business for a telecom operator.Also would like to know the calculation of break-even analysis.

  • Stanley Clark

    I need a sample copy ..on how to compute a break-even…how do you calculate it

  • krishna

    i want a sample copy of a break even point
    and how to calculate it..

  • mare

    Fixed costs don not change with a level of activity for a particular activity. e.g. rates insurance cost of machinery, overheads.
    you have a coffee bar
    -the price for each cupof coffee is 3-50 =selling price (SP)
    -milk, coffe beans and sugare cost 50cents = varieable costs (VC)
    – Fixed costs are 10000 (FC)
    -How many cups of coffee do you have to sell to breakeven in the first month.
    Breakeven = FC_
    CM (contribution margin)
    = $10000 (fixed cost) over
    3.50 minus 50cents
    = 3.00
    = 3.00 divided into 10000 (FC)
    = 3,333 cups of coffee

  • Gary Alexander

    How do you work out breakevens when your entire business is services rather than tangible goods sold?

  • jookem

    well gary, you would take into account the salaries(expenses) paid employees doing the services, and what you charge the clients (profit) for them.

  • doris

    rham,
    The basic formula for the break even analysis is as follow:

    P(x)=A+B(X)
    where P is the Per unit sales price (per unit revenue)
    A is the Fixed cost and B is the Variable cost per unit.
    If you basic algebra…you shoul be all set solving the equation…Good luck!

  • Hamida

    please i want to know why you don’t construct your total cost line when you are drawing the break even chart.

  • http://www.ArticlesForKnowledgeSharing.com Pankaj Trivedi

    Doris, you have simplified it nicely.

    -Pankaj

  • Mo

    How do you calculate the break even point for a service company?

    • http://www.businessingeneral.com Chelle Parmele

      Mo,

      Have you tried using our Break-Even Calculator? http://www.bplans.com/business_calculators/break_even_analysis.cfm

      That might be super useful in determining your break even for your company.

    • https://www.max-profits.com/ Max-Profits

      You can still determine the VC for a service company, just need to determine cost per hour your paying the employee working on each type of service you offer (on average) , and account for non billable hours. Then determine how much you’re billing your customer per hour.

  • Natalia

    Hi, Please help, how do I count a gross profit for each sale if it’s a day care center. THe wages and rent and utilities are included inthe fixed costs, does it mean I would have to show a 100% gross profit for each child? If not then I would have different number of kids and as a result I would need different number of employees, do I have to make a brake even for each number of kids or count the muximum I can have?
    Thank you

  • Luke

    If I receive a loan to purchase inventory, how do I factor the loan figure into my variable per unit cost? If I express my per unit cost as a variable cost and my principle loan amount as a fixed cost, am I not purchasing my inventory twice? Once with the variable expense and one with the fixed expense? So confused

    ————————————–
    The main point to keep in mind here is that the details of your loan should be kept separate from the inventory that you’ll be purchasing with that money.

    If you’ve chosen the option to manage inventory in your plan, Business Plan Pro will use the Cost of Sales information from your Sales Forecast to automatically estimate Inventory Purchases based on a few other assumptions that the program will ask you about. Those Inventory Purchases are automatically added to the Accounts Payable in your plan and flow through into the Cash Flow as part of the Bill Payments as they should be.

    The loan amount should be entered into the appropriate tables (Start-up Funding or Cash Flow depending on timing) and the Principal Payments for that loan should be entered into the Cash Flow table. Business Plan Pro will automatically calculate the Interest Expense on the loan and place that value at the bottom of the Profit & Loss statement for you.

    For additional information, please review:
    Cost of Sales
    Inventory Detail
    FAQ: Handling of Loans, Interest and Repayment

    Sean Serrels
    Product Trainer/Evangelist
    Palo Alto Software

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  • http://www.B-School.com Bill

    I run a internet startup and was thrilled to hear the analogy of burn rate. I’m not trying to convert everything to a post internet term and create a new age bplan :)

    Your explanations are very helpful

  • https://www.max-profits.com/ Max-Profits

    Although how would this account for the possible change in VC as the quantity sold changes? And the expected change in each variable as time continues, if it is expected to take several months to break even?

  • Boni

    I like this article and need to go through so as to make me get better business skills and management strategies on how to run a small entrepreneur in Tanzania