Breaking even is a huge milestone for every business. The break-even point (BEP) is the exact stage where your revenue finally equals the costs, and you’re on the edge of officially becoming a profitable business. If ever there was a moment to pop the champagne and do a little jig, reaching your break-even point would be it.
You should calculate your break-even point before you even open your business’s doors. This number tells you what it’s going to take (as far as sales and expected costs go) to eventually start making money. If your calculations don’t work out on the napkin, then it’s likely the business idea (or at least the pricing and efficiencies) aren’t going to work out in the long run.
First, let’s walk you through how to calculate your business’s break-even point. Then, we’ll show you how you can adjust your business’s strategy to make that milestone a reality.
How to Calculate Your Break-Even Point
Break-Even Point = Fixed Costs / Contribution Margin
Let’s break this formula down.
- Calculate your fixed costs. These are expenses like rent, salaries, property taxes, insurance, etc.
- Determine your contribution margin. Contribution Margin = Price of Product – Variable Costs. Your variable costs are expenses that fluctuate with production and sales, like the price of labor, commissions, or cost of direct materials.
- Divide your fixed costs by the contribution margin.
- Presto—there’s your break-even point! That’s how many products you’ll need to sell to make your revenues equal to your expenses.
Your product prices and costs will change from time to time, so you’ll need to recalculate your break-even point every time you make a change.
How to Use Your Break-Even Point
Now that you know your break-even point, you need to make strategic business decisions to reach it. You may crunch the numbers and nearly have a heart attack when you realize how many products you need to sell—but don’t panic! There are a few levers you can pull to manipulate this number and make your break-even point more realistic:
- Reduce Fixed Costs: You need money to make money, but the less money you use, the lower your break-even point. Take a look at your profit and loss statement, balance sheet, and cash flow statement to find out where your money is going. Your fixed costs are usually some of your bigger expenses, and they’re the harder ones to nix. Does your business really need the delivery van that’s eating up car payments? Can you cut back on inventory to reduce storage rent?
- Increase Prices: Pricing is tricky. You want to price your products high enough that they’ll turn a healthy profit, but you can’t raise your prices significantly above competitors without pricing yourself out of the market.
- Decrease Variable Costs: Look for areas to optimize the sale of every unit. Can you improve your digital marketing funnel to decrease ad spend? Can you find a supplier who charges less for your necessary raw materials?
With your break-even point on paper and your strategy in the making, you’re well on your way to turning your business into a profitable endeavor. Do the math, then make it happen!