What is the break-even point?

break even analysis

The break-even point is a critical number for every small business. Yet, many Canadian entrepreneurs don’t know the point at which sales will translate into profit. Let’s break down the break-even analysis and help you easily understand how it’s calculated.

Why is break-even important?

The break-even point is critical for entrepreneurs, because any money coming in over and above this number is profit! As well, knowing the break-even point can help an entrepreneur determine how much of an increase in sales is required to cover an increase in costs, and may be used when deciding whether to launch a new product.

How to calculate the break-even point

Break-even can be calculated using this formula:

Total Fixed Costs ÷ (Unit Price – Unit Variable Cost)

                                  (also known as contribution margin per unit)

To use this formula, the price of the product or service, per unit, should be known. Entrepreneurs will also need to know the variable cost, per unit, of the product. For example, variable costs for a shoe manufacturer could be the cost of the materials in each pair like leather, laces as well as that portion of labour that it takes to build each pair.

Next, subtract the variable cost per unit from the selling price per unit, to get the bottom part of the formula — the contribution margin per unit.

The top portion of the formula is total fixed operating expenses, things like a business’ rent, salaries not associated with manufacturing, utilities and so on.

For example, let’s say the selling price of an average bouquet at Jill and Lauren’s flower shop is $25. The variable cost of a bouquet, including materials and labour wages, is $5.00 per bouquet.

To figure out the contribution margin per unit, they subtract the variable cost per unit from the sales price. So, $25.00 – $5.00 = $20.00.

Let’s say the fixed costs of Jill and Lauren’s flower shop amount to $10,000. Now that they have all of our numbers, they can plug them into the formula to determine the break-even point, or the number of bouquets they’ll need to sell to cover their costs.

     $10,000                  =                      $10,000          =          500 bouquets
($25.00 – $5.00)                                      $20

Other analyses can be conducted with this knowledge. For example, product-focused businesses can take that number and divide it by the number of days they work per year to figure out how much they’ll need to sell each day to break even.

The break-even point in sales dollars can be determined by multiplying the break-even point in units by the selling price. This will give the entrepreneur the point where total sales equals total costs, in dollars.

For more insight into the break-even point and more, check out our online small business training – comprehensive but designed to fit around your busy schedule!

 

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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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