Break-Even Analysis: How to Predict If Your Next Business Venture Will Be Profitable
In any business, it goes without saying, you have to spend money to make money. But, how much money should you put towards making money? The most effective way to determine how much to spend as your initial investment is to conduct a break-even analysis. Conducting a break-even analysis will lower your risk and will tell you exactly how much you need to make to break-even or earn back your initial investment. Conducting a break-even analysis will assist you in predicting if your next business venture will be profitable or if it is even worth the investment.
What Is Break-Even?
When you break-even, the cost of doing business, including goods sold and fixed costs is equal to the revenue received from products or services sold. Break-even is the point at which your business makes enough sales to cover its costs. When you break-even, you have made enough money to earn back your initial investment, but you have not made a profit; you have just broken even because you have sold enough products or services to cover your costs.
Breakeven is where total revenues = total costs
Break-even is not a loss; it is the point in which you have made back your initial investment; all sales moving forward are considered a profit. Fixed costs and variable costs play a huge role in break-even analysis. Fixed costs are costs that remain unchanged with volume sold. Examples of a fixed cost include your employee salaries or your monthly rent. Variable costs are costs that change with volume sold. Examples of variable costs include product materials or packaging costs. A few formulas used to calculate your break-even include:
Unit Break-even = Fixed Costs/ (Selling Price – Variable Cost)
Revenue Break-Even = Fixed Costs/ ((Selling Price – Variable Cost)/Selling Price)
What Is Break-Even Analysis?
A break-even analysis is a financial calculation used to determine how many of your products or services you need to sell to at least cover your costs. A break-even analysis can help you to price your products or services better, determine how much of your product to order or purchase, or how much you will need to make to cover your fixed costs.
For example, last week, I conducted a break-even analysis to determine how many t-shirts I would have to sell to cover the cost of production. In this case, I was trying to determine whether or not it would be worth using the resources of the non-profit pet rescue for which I was volunteering. I conducted a break-even analysis to determine how many t-shirts we would have to sell at a fundraising event to break-even and at which price we would have to sell them to break-even sooner rather than later, so we could begin raising funds for our animals.
The cost of the t-shirt production was $19.50 per long sleeve shirt, $13.50 per women’s short sleeve shirt and $12.50 per racerback shirt; we intended to purchase 30 of each type of shirt. Because the t-shirts were being made to raise money for a non-profit organization, we had $0 in total fixed costs. Therefore, in order to break-even, we needed to calculate what the total variable cost would be.
$0 (Fixed Costs)
Long Sleeve: $19.50 X 30 shirts = $585 (Variable Cost)
Women’s Short Sleeve: $13.50 X 30 shirts = $405 (Variable Cost)
Racerback= $12.50 X 30 = $375 (Variable Cost)
$585 + $405 + $375 = $1,365 Total Variable Cost
After calculating the total variable cost of the t-shirt production, we knew that our break-even point was $1,365.00. Simply put, we knew that we had to make $1,365.00 in t-shirt sales to cover the cost to make the t-shirts. We also knew that we needed to make more than the $1,365.00 to make a profit and make it worth the rescues time and resources. But how much would we need to sell the shirts for, and how many shirts would we need to sell to reach our break-even point?
Because we calculated our break-even point before making our purchase order, we were able to price our products before purchase. By doing this, we were able to decide on a uniform selling price of $30.00 per shirt no matter the style of the shirt, and we were able to determine that our profit would be higher than our costs and that we would need to sell 46 of the 90 shirts to break-even. Every t-shirt sale after the first 46 t-shirts would result in a 100% profit for the pet rescue because we already broke even and covered our costs after our first 46 t-shirt sales.
$30.00 X 90 shirts =$2,700 (in sales)
$2,700 (selling price) – $1,365 (Variable Cost) = $1,335 (profit)
$1,365/$30 = 45.5 or 46 T-shirt sales to break-even
All said and done, a break-even analysis can help you to determine if your next business venture will be possible. Similar to the pet rescue’s t-shirt fundraiser example, a break-even analysis can help entrepreneurs and current business owners to make essential business decisions. By calculating your break-even before moving forward with a new business venture, you can determine whether or not this venture will be worth your time and resources and, at which point, your new venture will become profitable. There are many benefits to conducting a break-even analysis, and the results of the analysis can be beneficial in predicting the success of your next business venture.