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!