When starting a business, performing a break-even analysis is essential for projecting success by contrasting costs and revenues. The break-even quantity (BEQ), determined by the break-even analysis (BEA) formula, is the amount of product or services you must sell to make revenue equal costs. Completing this analysis will show you when you may begin making a profit and help you set realistic sales goals.
To calculate the BEQ, you'll need to know your fixed costs, variable costs and average price per unit. Here's how to develop your own analysis.
Fixed costs are your recurring monthly or annual costs. They include salaries, rent, vehicle payments and anything else that you pay out regularly. Remember that initial start up costs would skew your analysis, so don't include them unless they were paid for with financing that you repay monthly. For your estimated break-even point to be as accurate as possible, record each cost carefully. For our example, we'll use a fixed cost of $25,500.
Variable costs are the expenses directly related to the creation of a single unit of product. They may include packaging, materials, manufacturing and any other expenses needed to produce or deliver your commodity. If you don't know the exact costs of some items, research competitors or similar businesses to make a more accurate estimate. Once you've tabulated the costs needed to produce one unit, you will have your cost per unit. For our example, we'll use $50.
Price Per Unit
Next, determine your market price. Research the highest and lowest prices on the market for your product and similar offerings. Price your goods competitively within the market, but still higher than your cost per unit. If you're unsure of the best price, the outcome of the break-even analysis can guide you. The higher your profit margin is, the sooner you will hit the break-even point, and vice versa. For this example, our price per unit is $75.
Calculate the Break-Even Quantity
If you don't know the exact amount of the fixed costs, variable costs and average price per unit, make an educated estimate. After compiling these costs and choosing a price for your product or service, input the numbers into this equation:
BEQ = fixed costs / (average price per unit – average cost per unit)
When we plug in our numbers, it looks like this: $25,500 / ($75 – $50) = 1,020
What You'll Learn From a Break-Even Analysis
Once you plug the three costs into the equation, the result will equal the BEQ, or how many units you must sell to maintain the break-even ratio. This point is where your revenue equals your expenses. The break-even quantity in our example is 1,020, meaning you would have to make and sell 1,020 units before you would start making a profit.
Calculating a break-even point helps businesses develop pricing strategies, set sales targets and may also help demonstrate whether a proposed business concept is even viable.
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