The break-even point is defined as the point where sales or revenues equal expenses. There is no profit made or loss incurred at the break-even point. This figure is important for anyone that manages a business since the break-even point is the lower limit of profit when setting prices and determining margins. Obviously the break-even point becomes very important when calculating a strategy for net profit.
The break-even margin is a ratio that shows the gross-margin factor for a break-even condition. The formula is total expenses divided by net revenues multiplied by 100 to get a percentage. This ratio is helpful when setting prices, with competitive bidding and when negotiating contracts with vendors and accounts.
The dynamics of the break-even point and the break-even margin show managers the impact of their decisions. In purchasing, costs can be lowered by bulk purchasing, negotiating price/ terms or finding new suppliers. Revenues can be improved by increasing value to the customer or offering non-price concessions. It must be remembered that increasing profits by simply increasing margins is a risky strategy. Unless the consumer perceives higher value, increased prices may negatively impact sales. The customer ultimately decides benefit, value and sales.
When looking at break-evens it is also helpful to look at fixed and variable costs. Fixed overhead is steady and can be factored in quite accurately. Variable costs are not as simple to calculate but in many industries variable costs follow certain percentages or ratios so they are easier to project.
It is also helpful to look at break-evens on a daily, weekly, monthly and yearly basis. Many construction companies base their bids on when they hit their yearly break-even. Once that point is reached they can make their bidding more competitive to stay busy and profitable.
I have found if very useful to let personnel know the break-even figures. This gives them a very clear picture of expenses and what it actually takes to run the business. Sharing break-even figures also reduces the perception that ownership is getting rich off of the employees’ efforts.
If you do not know your break-even point ask your accountant to show you. Some bookkeepers are able to add the break-even point to their reports. If you think finding out the obvious is not worth the effort, just consider how many businesses have failed because they did not know their break-even point.
Jack D. Deal is owner of Deal Consulting 831-457-8806.