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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

Dollars

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

$25 = 62.5% of $40

62.5% = 0.625

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:

$15,000 ÷ 0.625 = $24,000

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 $40 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:

$15,000 ÷ $40 = 375 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 advertising dollars. 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: