Experiencing rapid growth is exciting– however many business owners find themselves in hot water when they realise revenue is less than expenses. It can be a scramble to work out why sales are not offsetting your outgoing costs, pinpoint where the loss of profit is occurring and how to turn it all around. Understanding your business’s break-even point is critical to maintaining outputs that equal your revenue. But what exactly is a break-even point and how does it relate to solving loss of profit issues?
Understanding the break-even point.
Put simply, the break-even point specifies how many units of stock you need to sell to cover your outgoing expenses, or if you are a service provider, how many hours you need to work to ensure all the bills are paid. It indicates at which point the business will make $0 of earnings before interest and taxes or EBIT.
If a business is operating at $0 EBIT, no profit is being made. ‘Breaking even’ is not an ideal situation for any business owner, which is where the concept of a safety margin comes into play.
The Margin of Safety
Drawing on historical sales and expense data can help a business determine its safety margin. A simple subtraction calculation (total sales minus your break-even figure = your safety margin) allows you to understand by how much your revenue can safely decline before you risk slipping below an EBIT of $0.
How should the break-even point be calculated?
Now for the big question: how to calculate your break-even point? Firstly, you will need a thorough understanding of your fixed costs (these are the expenses that aren’t affected by sales volumes such as tenancy or lease fees, and insurance) and your variable costs (these expenses are going to rise and fall depending on sales or production levels, such as the cost of raw materials and delivery fees).
To ensure a good profit margin, it is important to have accurate fixed and variable cost data, otherwise, you won’t be able to accurately determine your break-even point.
You will also need to have calculated an average selling price for your goods and/ or services. Using guesswork in your break-even calculation will hurt you in the long run and is a common reason for businesses slumping below $0 EBIT.
Here is how you calculate your break-even point in units:
|Fixed Cost ÷ (Sales Price Per Unit – Variable Costs Per Unit) = Break-Even Point|
What if my current revenue is less than my break-even point?
If alarm bells are ringing due to the business operating at a loss, there are some practical steps you can take to improve your financial position.
How much are your fixed expenses really costing you?
Remember, fixed expenses stay the same regardless of revenue. Reducing your overheads can positively affect your break-even point. It is, however, important to analyse the effects of reducing these fixed expenses. For example, reducing labour costs through layoffs can overload your remaining employees, reduce morale and result in slower or reduced outputs. A trusted advisor may suggest refinancing loans and debts or looking at alternative insurance options first.
Sell, sell, sell.
Driving revenue and business growth may seem like an obvious solution, but not understanding the minimum level of sales that must be achieved to generate a profit can be a precursor to revenue being less than your expenses. Working on a pricing strategy, diversifying your marketing and focusing on existing, repeat customers can increase revenue.
A deeper cost analysis.
Analysing the costs that are closely attached to generating revenue can change your break-even point for the better. If you find yourself going in circles and unable to pinpoint your break-even point or safety margin, our specialist business advisors can help. By providing a deep analysis of your financial performance, we can determine your break-even point and forge a path forward to optimal profitability.