Break-Even Point, What is it? How do I calculate it?
Break even point is an important calculation for any business plan and it is the point at which you have sold enough to pay for all the Direct Costs (in other words all the products, materials, widgets, or whatever that you had to buy in order to sell) and also paid for all the Overheads (including your salary/wages or Drawings) for the full year.
It may be expressed in terms of
Value - How much you had to sell in £'s - or $'s to break-even
Time - How long it takes you to reach break-even point in weeks or months
Quantity - How many sales you had to make to reach break-even
You can also calculate how many sales, or items, you have to sell on average per week to reach break-even by the end of the trading year.
Although there are many formulae that can be used to calculate break-even, one of the simplest ways and easiest for the Bank manager (or any other funder) to understand is by Graph.
Imagine that you have calculated all of your Overheads, produced a Sales Forecast and know what the Direct Costs are associated with that Sales Forecast and have come out with the following figures
Direct Costs £5000
Then to construct the graph make the £ line equal to the total Sales Value (£25,000) and the time line equal to 12 months (for a years break-even calculation)
The next step is to draw a line at £10.000 to represent overheads and a line at £15,000 to represent Direct Costs (remember Direct Costs are added to Overheads because you need to pay both to reach your Sales Forecast.
The next step is to draw a line at £25,000 to represent the Forecast Sales
On day 1 of your business you have made no Sales and on day 365 you will have reached £25,000, therefore draw a line between these 2 points
Similarly on day 1 you will not have incurred any Direct Costs and so the only thing to pay is Overheads. On day 365 you will have bough £5.000 Direct Costs so draw a line between these two points.
Guess what? Where the two lines cross is your break-even point ( on this example at £12,500 of Sales sometime in the middle of June). If you know how much you are going to sell each item for then you can work out how many items you need to sell to reach £12,500 Sales and that is Break-Even
The major advantage of this system is that you can see, at a glance, where the best areas to work are to improve break-even. For instance a 10% reduction in Direct Costs will give the same improvement as a 5% saving in Overheads or a 4% (approx) increase in price - so you may be better off putting up your price a little rather than battling with suppliers for a discount.