An important tool in any business owner’s kit is a breakeven analysis. In it’s most basic form, this analysis tells you how much you need to sell to cover your costs.
You would use a breakeven analysis in any situation where you need to know how much you have to sell. For example:
- Starting a new business or launching a new product
- Considering a price change
- Setting quotas or sales goals
- Considering taking on new expenses
Before I get to the actual formula, I need to explain a few of the pieces that go into it.
Fixed costs: Your fixed costs are the costs your business incurs whether you sell anything or not. Some examples of fixed cost are rent, salaries, utilities, advertising, etc.
Variable Unit Cost: These are the costs you incur when you sell something. For example, the cost (to you) of the item or the materials, sales commissions, delivery cost, etc.
Unit Sale Price: What you charge for the thing.
Unit Margin: Unit Sale Price – Variable Unit Cost
Breakeven Units: The number of items you need to sell to cover your costs.
The basic breakeven formula is:
Breakeven Units = Fixed Costs / Unit Margin
So, if we had fixed costs of $5,000 per month and sold a $200 item that cost us $100 each…
Breakeven Units = $5,000 / ($200 – $100) = 50.
We would need to sell 50 units per month to not lose money. Of course, you would need to decide if selling at least 50 units at $200 per month is realistic.
This formula doesn’t predict demand or profit or anything else. It tells you the smallest amount you need to sell to cover your nut.
Here’s another example of how you might use the breakeven formula:
Let’s say you’re considering a move to a bigger, more expensive location. We’ll use the previous example as the situation at your current location. Your new rent is going to increase your fixed cost by $1,500 per month.
Applying the formula…
Breakeven Units = $1,500 / ($200 – $100) = 15
You would have to increase your sales by 15 units per month to cover the extra cost.
One last example. Let’s figure out how much you need to sell to reach a certain level of profit. Make one small change to the formula.
Unit Volume = (Fixed Cost + Desired Profit) / (Unit Sale Price – Unit Variable Cost)
So, if we wanted to end up with $2,000 in profit each month…
Unit Volume = ($5,000 + $2,000) / ($200 – $100) = 70
We would need to sell 70 units each month.
This simple breakeven analysis can save you thousands of dollars and a lot of stress. Use it before you launch or make big changes so you understand what it’s going to take to succeed.
Like seeing the numbers in your business? Check out how to figure out your customer’s lifetime value.
Need help figuring out how you’re going to reach those sales volumes? Get in touch.