How to conduct a break-even analysis

A break-even analysis is a tool used by small business owners to calculate the amount of sales needed to cover all costs – the point when they break even. This can also be used to determine how much of an increase in sales you’ll need to cover your cost increase, and may be used when deciding whether or not to launch a new product. We’re looking for the point where Total Revenues are equal to Total Costs.

Here is the formula to calculate your small business’ break-even point:

Total Fixed Costs ÷ Contribution Margin Per Unit: (Unit Sales Price – Unit Variable Costs)

To use this formula, you need to know the sales price of your product or service, per unit. For example, let’s say you own a screen-printed t-shirt small business. The sales – or unit – price of one of your t-shirts is $20.00. You’ll also need to know the costs which vary with the amount of business you do, per unit, of your product. For example, the variable cost of a t-shirt, including materials, utilities and labour wages, is $5.00 per t-shirt.

Next, you want to subtract the variable cost per unit from the sales price to give you the contribution margin per unit. So, $20.00 – $5.00 = $15.00.

Now, to get the total fixed costs number, you must know total fixed operating expenses (costs that stay the same no matter how many t-shirts you make). Let’s say the fixed costs of your t-shirt shop, including rent, taxes, insurance, and all other unchanging costs that must be paid to keep your business running, amount to $10,000.

Now that we have all of our numbers, let’s plug them into the formula to determine the break-even point, or the number of t-shirts you have to sell to cover your costs.

$10,000 ÷ $15 = 666.67, or 667 t-shirts per year rounded up

If you need to sell 667 shirts a year to break even, how many shirts will you have to sell each day? Let’s assume your store is open six days a week, or 312 days per year. You would need to sell 2.13 t-shirts per day, calculated as follows:

667 ÷ 312 = 2.13, or three shirts per day rounded up

For your t-shirt company to make a profit, 667 t-shirts must be sold per year. The income from these 667 t-shirts will cover the costs of making them, and the sale of the 668th shirt will result in a profit. As a small business owner, try to keep your fixed costs down. The higher the fixed costs, the higher your break-even level of sales will be and the harder you’ll have to hustle!

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How to determine pricing for your small business

You’re ready to start selling your great new service or set of products. So, how much are you charging? If your answer to that question was a shrug, read on!

Figuring out your pricing

Finding a good price for your product or service can be tricky. You need to find a balance between a price that’s appealing to customers but will also make you money. It’s also easy to doubt or second-guess your decisions. You may want to charge a high price to make more money, or charge a low price to undercut your competition. It’s a fine balance, with several elements in it.

Consider these things when figuring out what to charge for your small business’ offerings:

  • The costs that go into the development of this product or service – both fixed and variable. If you don’t at least cover these costs, you’ll lose money.
  • The prices of similar products or services that already exist in the market Try to stay within that range. How does your product compare to others in the industry? Are your customers willing to pay more for a new feature, or do higher prices meet with complaint?
  • The values associated with your product or service that are behind the scenes – things like reputation, durability and customer service.

The three methods of determining price

  • Cost-Based Pricing. This method involves setting your price high enough to cover the costs you generate when producing your product. Mark-ups can range from 10% to 60%.
  • Value-Based Pricing: Wit this method, you figure out the value customers receive from your product or service. Is your product exceptionally well-made? Is there prestige attached to your name (like with designer clothing)? Do you have unusually good warranties or customer service? Are you an expert in your field? Value-based pricing tells you what your customers are willing to pay, rather than just covering your production costs.
  • Competition-Based Pricing: Here, your base price follows what your competition is charging. Where you fall in this line depends on your industry, image and what you’re offering. With luxury items, it’s not unusual for prices to reach on the high side to seem more extravagant. But with convenient and common products or services, prices are often on par with or even lower than the competition (think of all the sale flyers you receive and the kinds of companies that send them). Choose your prices carefully with this method – prices way off the mark can see your customers flock to your competition.

Good luck and happy selling!

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