We all know that the breakeven point in a company is when it does not make a profit or lose money. Sounds simple right? Well, can you tell me what your exact break-even point is? Probably not. Most business owners don’t know or think they do, without either of them knowing exactly. The breakeven point can be expressed as a dollar amount or unit sales, and once it is determined, you have a goal to achieve through a carefully thought out business plan. Without a balancing goal in place, your strategic plan falters.
It is very important to understand that increased sales does not always translate into increased profits. Many companies have gone bankrupt by ignoring the importance of equilibrium analysis, thinking that increased sales will lead to some profitability. Unfortunately, most of the time, the company’s variable costs, or those derived directly from sales levels, increase exponentially as sales volume increases. Not knowing variable costs is a silent killer for many companies.
When calculating the breakeven point, you will have to make certain assumptions and estimates. Error on the side of conservative figures by using more pessimistic sales and margin thresholds, while overstating projected costs. You want the breakeven point to be in the safe zone, a worst-case threshold. I will present some Breakeven formulas that err on the simple side, it can get very complicated with different variations of Breakeven’s Formula. The point I’m making here is to provide some simple formulas so you can quickly calculate your Breakeven and understand where you currently are and how it looks projected. Once you have a grip on that, then perhaps a more sophisticated Breakeven Analysis is justified and advantageous. Keep it simple to get started.
Equilibrium formula: S = HR + VC
S = Break-even point of sales in dollars
FC = Fixed costs in dollars
VC = Variable costs in dollars
Fixed Costs – Costs that remain mostly constant despite sales volume. Fixed costs remain constant in a certain range, after which they change, particularly after a sharp increase in sales (i.e. you need a larger building or more employees). It is important to understand that these costs must be paid regardless of whether the company makes sales or not.
Fixed costs include:
– General expenses: rent, office / administrative expenses, salaries, benefits, FICA, etc.
– Interest charges: for term loans and mortgages.
– Hidden costs: depreciation, amortization and interest.
Variable costs: costs directly associated with the level of sales and include:
– Costs of goods sold
– Variable labor costs
– Sales commissions
When you don’t know what your variable costs will be, you can use a variation of the balance formula, as long as you know what your gross margin will be as a percentage of sales:
S = FC ÷ [1- (Variable Expenses*) ÷ Sales]
*: VE includes Material Costs, Variable Operating Expenses and Variable Labor.
To get the Breakeven in Units Sold, divide the Breakeven Quantity in Dollars by the Unit Price.
Why is equilibrium analysis important?
– You can plan ahead and determine the amount of financing needed to grow the business.
– By graphing Balance Analysis, it is much easier to make Strategic Objectives more tangible and achievable.
– You can use the equilibrium formula to measure your company’s progress toward profit goals. It is an excellent tracking tool when graphically represented and can work in conjunction with your strategic plan milestone objectives.
– Understand what your breakeven point is when setting profit goals through the formula:
S = FC ÷ [1- ((Cost of Sales + Variable Operating Expenses) ÷ Sales)]
– Balance charts help your employees visualize your company’s progress toward profit goals.
– Once you know your equilibrium sales level, you can divide that sales level into the required number of customers.
– Enter three sales values (best, worst case, and most likely) to determine when your fixed costs will be covered. This is invaluable when planning your financial requirements.
– The Breakeven Analysis is an excellent process for determining the effect of different unit costs on expected sales for each type of unit. Understanding your most profitable units and how they relate to profitability and profitability goals is at the core of your marketing strategy and your sales and strategic plan.
If profitability analysis is used as a tool to realistically understand profit projections and profit analysis, it is extremely effective. A business owner and their employees, knowing on a daily basis what it takes to break even for the applicable month, quarter, or time period, is a powerful tool in achieving a company’s profit goals. Also, balance analysis is directly affected by a company’s marketing plan and vice versa. The Company’s Strategic and Sales Plan is a performance of the Balance Analysis. When you think about it this way, balance analysis is at the core of the planning and analysis necessary for business success. It’s a great tool, only if you use it!