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Breakeven Analysis

Breakeven analysis is a tool used to determine when a business will be able to cover all its expenses and begin to make a profit. For the startup business it is extremely important to know your startup costs, which provide you with the information you need to generate enough sales revenue to pay the ongoing expenses related to running your business.

A startup business owner must understand that $5,000 of product sales will not cover $5,000 in monthly overhead expenses. The cost of selling $5,000 in retail goods could easily be $3,000 at the wholesale price, so the $5,000 in sales revenue only provides $2,000 in gross profit available for overhead costs. The breakeven point is reached when revenue equals all business costs.

To calculate your breakeven point you will need to identify your fixed and variable costs. Fixed costs are expenses that do not vary with sales volume, such as rent or administrative salaries. These costs have to be paid regardless of sales and are often referred to as overhead costs. Variable costs vary directly with the sales volume, such as the costs of purchasing inventory, shipping, or manufacturing a product.

The formula for determining your breakeven point requires no more than simple arithmetic.

Break-Even Analysis

Break-even analysis pinpoints where revenue equals total costs. To calculate your break-even point, take your most current income statement and identify each cost as either fixed or variable. Fixed costs are independent of sales level, while variable costs rise and fall with sales. Mixed costs involve elements of both. Most costs will fall readily into fixed or variable. For those that don't, allocate 50% to fixed costs, and 50% to variable.

Fixed Expenses:                     Variable Expenses: 
________________________________________________________________
Salaries                            Sales commissions 
Office expenses                     Taxes 
Payroll tax                         Sales tax 
Benefits                            Boxes, paper, etc. 
Utilities                           Travel and entertainment 
Rent                                Freight 
Licenses and fees                   Overtime 
Operating supplies                  Bad debts 
Insurance                           Cost of goods sold 
Advertising                         Car/delivery 
Legal and accounting                Postage
Depreciation
Interest
Maintenance and cleaning
Dues and publications

Computing Production Needs

It can be most important to small manufacturers to know the quantity of production units they must produce in order to cover the firm's fixed expenses.

This formula is:
                                          Fixed Expenses
Break-even point in units = _____________________________________________
                                    Contribution margin per unit 
                            (unit sale price - variable expenses per unit) 

Computing the Break-Even Point in Sales

Where the immediate objective is to find only the sales volume that is necessary to reach the break-even point, this formula should be used.

                                          Fixed Expenses
Break-even point in units = _____________________________________________
                                    Contribution margin per unit 
                            _____________________________________________
                                      Selling price per unit

This break-even formula determines how many units the firm must produce and sell to pay for fixed expenses. It subtracts the variable expense per unit from the sales income for each unit. The difference per unit is then applied to fixed expenses. The break-even quantity is the number of units that must be sold to cover expenses.

Example:

The Successful Company sells decal-decorated T-shirts to its customers for $10.00 each. The shirts cost $4.00 each, and the decal costs $.40. The store pays a $.60 commission to the salesperson. The total variable cost is $5.00. The total of the fixed costs is $1,500 a month.

Using the Formula for Computing Production Needs we find that, dividing the monthly fixed cost of $1,500 by $5 gives a break-even point of 300 shirts per month. If we sell 300 shirts at $10 each we generate $3,000. Our variable costs total $5 per shirt or $1,500. Add the fixed cost of $1,500 to variable costs of $1,500 equals $3,000.

                              Breakeven Point =           $1,500
                                                 _________________________
                                                 $10 - $5 = $5 = 300 units 

Assumptions and Special Remarks

Describe and give reasons for any assumptions you have made in assembling your business plan. Such as assumptions concerning the economy or your competitors. Document the source of information on which you based your assumptions.

Also, list any special remarks you wish to be known about your business. In the body of your business plan you should footnote where you have made an assumption or have special remarks about a subject in this section.

Appendices

Insert here deeds, titles, leases, licenses, certifications, contracts, letters of recommendations, letters of intent, industry standards, promotional materials, or pertinent articles from the media regarding the industry or your business which are mentioned in your business plan. Footnote your plan so a reader can easily find any document you refer to in the text in the Appendices.