The Break-even Analysis lets you determine what you need to sell, monthly or
annually, to cover your costs of doing business--your break-even point.
Illustration 1 shows the Break-even Analysis table from
Business Plan Pro.
The Break-even Analysis table calculates a break-even point
based on fixed costs, variable costs per unit of sales, and revenue per unit of
sales.
Understanding Break-even The break-even analysis is not our favorite analysis because:
It is frequently mistaken for the payback period, the time it
takes to recover an investment. There are variations on break-even that make
some people think we have it wrong. The one we do use is the most common, the
most universally accepted, but not the only one possible.
It depends on the concept of fixed costs, a hard idea to
swallow. Technically, a break-even analysis defines fixed costs as those costs
that would continue even if you went broke. Instead, you may want to use your
regular running fixed costs, including payroll and normal expenses. This will
give you a better insight on financial realities. We call that “burn rate”
these post-Internet days.
It depends on averaging your per-unit variable cost and
per-unit revenue over the whole business.
However, whether we like it or not, this table is a mainstay of financial
analysis. You may choose to leave it out, but really, a business plan would
not be complete without it. And, although there are some other ways to do a
Break-even Analysis, this is the most standard.
The Break-even Analysis depends on three key assumptions:
Average per-unit sales price (per-unit revenue): This is the price that you receive per unit of sales. Take into account
sales discounts and special offers. Get this number from your Sales Forecast.
For non-unit based businesses, make the per-unit revenue $1 and enter your
costs as a percent of a dollar. The most common questions about this input
relate to averaging many different products into a single estimate. The
analysis requires a single number, and if you build your Sales Forecast first,
then you will have this number. You are not alone in this, the vast majority
of businesses sell more than one item, and have to average for their
Break-even Analysis.
Average per-unit cost: This is the incremental cost, or variable cost, of each unit of sales. If
you buy goods for resale, this is what you paid, on average, for the goods you
sell. If you sell a service, this is what it costs you, per dollar of revenue
or unit of service delivered, to deliver that service. If you are using a
Units-Based Sales Forecast table (for manufacturing and mixed business types),
you can project unit costs from the Sales Forecast table. If you are using the
basic Sales Forecast table for retail, service and distribution businesses,
use a percentage estimate, e.g., a retail store running a 50% margin would
have a per-unit cost of .5, and a per-unit revenue of 1.
Monthly fixed costs: Technically, a break-even analysis defines fixed costs as costs that would
continue even if you went broke. Instead, we recommend that you use your
regular running fixed costs, including payroll and normal expenses (total
monthly Operating Expenses). This will give you a better insight on financial
realities. If averaging and estimating is difficult, use your Profit and Loss
table to calculate a working fixed cost estimate—it will be a rough estimate,
but it will provide a useful input for a conservative Break-even Analysis.
Illustration 2 shows a Break-even chart. As sales increase, the
profit line passes through the zero or break-even line at the break-even point.
The illustration shows that the company needs to sell
approximately 1,222 units in order to cross the break-even line. This is a
classic business chart that helps you consider your bottom-line financial
realities. Can you sell enough to make your break-even volume?
The break-even analysis depends on assumptions made for average
per-unit revenue, average per-unit cost, and fixed costs. These are rarely
exact. We recommend that you do the break-even table twice: first, with educated
guesses for assumptions, as part of the initial assessment, and later on, using
your detailed Sales Forecast and Profit and Loss numbers. Both are valid uses.
Copyright 2003, Timothy J. Berry, reproduced with permission,
all rights reserved.
Tim Berry is a business planning expert, author of several
books and planning software packages such as
Business Plan Pro.
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