The education required to calculate your Break Even Point (Formula)
No one should start a new venture without
(1) knowing their break even point,
(2) believing it can be achieved and
(3) being able to convincingly defend and communicate that belief to all potential stakeholders.
For the entrepreneur, the achievement of the Break Even Point is a special milestone, for it has vindicated their judgement to take the risks to launch the new venture. They have done their job … they have created new economic value. This article gives you the education to calculate your Break Even Point, Break Even Analysis and the Break Even Formula.
Introduction – Break Even Education
Many people that start new ventures are least concerned with the concept of break even, because they wrongly believe that they will make a profit from day one.
Sadly, it is this view that causes many of these business to fail because they have not provided sufficient working capital to support their venture until it reaches that point of profitability.
However, most seasoned entrepreneurs and new venture financiers will tell you that it typically takes 18 months to 2 years for a new venture to break even. So, the question needs to be asked ….
“What’s your Break Even Point?”
However, no one should start a business without; firstly knowing their break even point, secondly believing it 100% achievable andThe answer to this question is of critical importance for a new venture as both the entrepreneur and the interested stakeholder needs to know the answer. You will be forgiven for not having a definitive answer to “How much money can you make?” because there is lots of blue-sky and unfounded assumptions included in that answer and finally being able to defend and communicate that belief when required.
Definition: The break even point is the point at which the revenue from your sales equals the total costs incurred in achieving those sales. This can be expressed in volume of units sold (i.e. 500 units sold per week = Unit Break Even Point), customers (i.e. 50 customers a month = Customer Break Even Point), $ sales (i.e. $10,000 a month in sales = Revenue Break Even Point) or as a point in time (i.e. 18 months after opening = Time to Break Even).
The Entrepreneur and Break Even
The main game for the entrepreneur should always be to get the new venture from launch status to financial sustainability. The break even point marks the point at which the new venture takes its first steps into the financially sustainable realm. It does not mean that you have recouped your losses to date, it simply marks the point at which you stop incurring them (losses).
In large part, the break even point also represents the beginning of the end of the entrepreneurial reign, because entrepreneurial skills should gradually give way to business management/administration skills once this point is reached and passed. It is the break even point that marks the beginning of the transformation that must take place in every new venture where the focus and intensity moves from building the business (getting customer acceptance of the benefits offered) to building the profit (getting a financial return for the owners).
Unlike other investments, the sad reality of an investment in new ventures is that until the venture reaches financial sustainability (break even point) it is virtually worthless or at best valued only at asset liquidated value (sometimes this is only 10% of what the assets cost you).
So, the break even point is an important milestone for the entrepreneur because they have done their job, they have created new economic value and their judgment, in taking the risks necessary to launch the venture, is vindicated.
To the seasoned entrepreneur, the break even point is the main focus when launching a new venture, not the fortune that they can make. Fortunes, in large part, are in the ‘the lap of the gods’ territory whereas the ability to achieve the break even point is squarely in the entrepreneur’s. Seasoned entrepreneurs know their break even point, believe it can be achieved and have the overwhelming confidence, steely determination and wholehearted commitment to make it happen.
“Fate is gambling without the profit motive for fate must break even on the total number of winners and losers it creates every day” PB
Education about different Break Even Points
When evaluating an investment in a new venture there are three main break even points that may be considered. (1) Financial Break Even (2) Sustainable Break Even and (3) Equity Break Even.
Sustainable breakeven is the revenue volume point where all contributors to the venture’s income, including the founders, are appropriately compensated. This includes proper compensation for the founders time, market returns on equity investments made and proper ‘market-rate’ payments for any other contributions made to the venture. This is the minimum level that the entrepreneur should strive for in any new venture undertaking. It is my opinion that, due to poor business modeling, fewer than 50% of all new ventures make it to this point with most falling somewhere between these two break even marks.Financial break even is the revenue volume point where all external financial obligations are met. By external I mean those obligations that don’t include those of the equity (owners & investors) internal founders. At this point the new venture is not considered successful but it has at least been saved from being taken out of the game by external players.
Equity breakeven is the point at which the investors in a new venture have recovered their investment or have earned the same amount out of an investment as what they put in. The time taken to achieve this is often called the ‘payback period’. This break even type is of great importance to investors and venture capitalists but is not dealt with in this knol.
“Profit is the reward for delivering the appropriate service in the most efficient way” PB
Education about how to calculate a Break Even Point?
Simple … the break even formula for units looks like this:
Unit Break Even Point per month = (Fixed costs per month) ÷ (Unit $ Contribution Margin)
the Unit $ Contribution Margin = (Unit selling price – Unit variable costs) or the excess of the selling price over the variable costs.
It looks simple enough but unless you are an accountant, you probably don’t know what the terms fixed cost and variable cost mean. So let me explain.
Fixed costs per month are those costs you need to spend to maintain your business or product sales each month but which do not change in line with changes in your sales volume or business activity. Rent is a good illustration of a fixed cost. Regardless of how much you sell, the rent is still going to be the same. Other fixed costs could include equipment rental or lease arrangements, insurance, interest on debt, plant and equipment expenses, utilities, business licenses and salaries of permanent full-time workers.
Variable costs are those costs that do vary in line with and usually in direct proportion to changes in sales volume or business activity. Usually the largest and most common variable cost is the costs of buying or manufacturing the goods that are sold. This cost is often referred to as Cost of Goods Sold (COGS). Other variable costs might include packaging, and labor directly involved in a company’s manufacturing or sales process, vehicle fuel and salesperson’s telephone calls.
If you know these numbers already then you can use the many breakeven calculators offered for free on the internet. One that you could use is from dinkytown.com. Check it out. Breakeven Calculator
If you are still having difficulty in calculating these numbers then it may be best to do the following exercise to calculate the Monthly Revenue Break Even Point..
Steps to Calculating your Break Even Point
Step 1 – Formulate a monthly sales & costs profile
Try and look ahead to a monthly sales point at which you believe your business will be successful (usually in 1-2 years time) and picture all the types and probable amount of cost that would be associated with earning those sales. Now put these numbers in the following monthly worksheet. If they are yearly/annual costs then divide them by 12 to get a monthly equivalent. Examples are provided.
|MONTHLY SALES $||
|Cost Of Goods Sold||
|TOTAL VARIABLE COSTS||
|Equipment rental or lease||
|Interest on debt||
|Salaries of permanent full-time workers||
|TOTAL FIXED COSTS||
Step 2 – Calculate the contribution margin %
Divide the Total Variable Costs ($10,000) by the Monthly Sales $ ($20,000) to produce a percentage/contribution value. (10,000 ÷ 20,000) = 50% or 0.50
Step 3 – Calculate your Monthly Revenue Break Even (sustainable)
Monthly Revenue Break even = (Fixed Costs per month) ÷ (Contribution Margin %).
(7,000 ÷ 0.50) = $14,000. This means that given these assumptions, you would need to make $14,000 per month is sales to pay for all costs (both your variable costs and your fixed costs). Now take out of the costs those payments made to internal equity founders and then recalculate. This figure will give you your Monthly Revenue Break Even (financial) and the target you must get to or face failure.
Step 4 – Calculate the Customer Break Even Point
You will need to estimate, from your market research, what average $ sales amount your customers typically spend each time they purchase your products. You then divide this number into the Monthly Revenue Break Even amount to get the Customer Break Even Point. In the example given above, if the average customer spend was $14 per transaction then we would need ($14,000 ÷ $14) = 1,000 customer transactions per month to break even.
Step 5 – Develop your break even scenarios
Your current break even represents the most probable case. It may also be beneficial to calculate your best and worst case scenarios. Simply change the costs in the probable case to represent these views. Increase your costs to their highest likely levels to get worst case and reduce them to their lowest to get the best case. Recalculate. This gives you an overview of the full range of break even scenarios.
Step 6 – Now ask yourself these questions and give yourself an honest answer.
Do I 100% believe that I can achieve this level of sales? Why?
Peter Baskerville is a lecturer, educational resource developer and entrepreneur.
Author: Peter Baskerville