# Break-even analysis

The break-even point is the point at which your company makes enough money to cover its costs. Past this point, the company starts to make profit. Finding the break-even point through the analysis of costs is one of the most useful processes an entrepreneur can undertake. It helps you answer questions such as:

- What volume of sales do I need to break even?
- What profit can I expect from a particular volume of sales?
- What price should this product be sold at?
- Should advertising be increased or decreased?

### How to carry out a break-even analysis

**1. Separate your variable costs from your overheads**

Make a tally of all your costs separated by type – either fixed or variable. If you come across a mixed cost, like a bill with a flexible usage fee and a flat subscription cost, work out which is the greater part and add it to the appropriate list. You want to finish knowing two things: your **total fixed costs** and the average variable cost of providing one product or service (known as the **variable cost per unit**). If you take away the variable cost per unit from your sales price, you have your **contribution (or profit) margin**.

**2. Now carry out the following calculation to find your break-even point**

### Pounds

To obtain a break-even point in pounds, you need to express the contribution margin as a decimal figure converted from a percentage. For example:

£10 = 66.6% of £15

66.6% = 0.666

Now simply divide the fixed costs by the contribution margin (decimal figure). So, our window cleaner’s annual sales target to cover costs would therefore be:

£5,000 ÷ 0.666 = £7,507

### Hours

If your business is a service provider that charges an hourly rate, you’ll want to know your hours-worked break-even point. Simply divide your fixed costs by your hourly call out rate. Say, for example, our window cleaner decided to charge £20 by the hour, after finding out a minority of jobs were taking up a lot of his time. His hours target to reach break-even would be:

£5,000 ÷ £20 = 250 HOURS

Again, in both cases, he’d be wise to factor his salary expectations into his costs for a truer figure.

### Advertising spend

While break-even analysis is typically used to set a sales benchmark or estimate when a business will become profitable, it is also a fundamental tool when it comes to budgeting for advertising. Many businesses neglect to apply any analysis to advertising spend at all, especially if they are used to a set spending pattern every year. However, applying a break-even analysis to your advertising spend tells you exactly how effective that ad must be before the cost is paid for and it starts to help you make a profit.

The calculation is virtually identical to the standard equation – just replace your fixed costs with the cost of the ad:

### Weighted average price

Most companies make multiple products that cost varying amounts to make, yet their owners still need to know a single break-even point. To work this out, they multiply the price of each product by the average quantity they estimate to sell, before adding together a total of results, such as:

Dividing the total forecasted sales value by the total units they forecast to sell gives them a weighted average price = £4. This can then be used along with their weighted variable cost per unit (found using the same method) in a break-even equation.