Starting and running a small business is a bit like trying to white water raft upstream. You can paddle, dodge, and fight, but somehow, there are always more waves of expenses ready to knock you back down to zero.
Luckily, true entrepreneurs get a kick out of a challenge. They know to expect and fight those waves. And they also know how to measure their forward progress—however incremental.
In this battle towards profitability, keeping your eye on the prize and knowing how to track your financial wins is vital to long-term success. And one of the best ways to measure your progress, strategize your paddling, and dodge boulders, is by calculating your break-even point.
What’s a break-even point?
Your break-even point is the point at which your total costs and your total revenue are equal. In other words, you have equal amounts of money flowing in and out of your business. Now, ideally, you want to hike up the inbound flow until you're flooded with profits; but for a small business, establishing a steady stream is a strong start. After all, staying stable and afloat is always better than being pulled under by the current of debt.
How to calculate your break-even point.
“Calculate” might be one of our favorite words, but most people aren’t passionate accountants. Luckily, it’s actually very simple to calculate your business’ break-even point!
You’ll only need three variables:
- The total of your fixed costs for one year (costs that do not change, such as rent)
- The variable cost per unit (the costs that change as volume changes such as material costs and labor costs)
- The sale price of one unit of your product
Then, you’ll simply pop those numbers right into this handy formula:
Fixed Costs ÷ (Price - Variable Costs) = Break-Even Point in Units
Let’s look at a simple example, harkening back to our fond memories of math problems with large amounts of fruits.
Let’s say Mary sells delicious, juicy watermelons. Her fixed costs for her watermelon stand for the year are $5,000. Her variable costs per watermelon come to approximately $0.25, and she currently sells each watermelon for $3.
In the formula, that would look like:
$5,000 ÷ ($3 - $0.25) = 1,818.2 units
That means in one year, Mary needs to sell 1,818.2 watermelons to break even. We’re not sure who’s buying that 20% of a melon, but who knows? Maybe a kid with a dollar needed a snack and that sent Mary over the line into a successful fiscal year.
It should be noted that sale quantity isn’t the only way Mary can break even. Increasing her melon price to $4 would knock down the number of needed sales to 1,333. However, she might scare off buyers who are used to the $3 price. Or there may be another rival fruit stand selling their watermelons for $3.50, and Mary needs to stay competitive. It’s all about finding the balance between melon cost and melon value.
When should a new business break even?
It’s every pesky investor’s favorite question, right? When am I going to see my money?! Unfortunately, even if you don’t have a clear answer, you have to at least have an idea and a plan to get there. Keep in mind, not every business is the same. Some new companies break even in a matter of months, whereas some can take several years.
The important thing is that you have a specific time frame goal in mind so that you can realistically work to get there. Because truly, when was the last time “Oh, we’ll get there eventually” worked as a plan? No investor wants to hear that. Even if it’s five years out, a solid plan is always a better move than blind faith.
Does it even matter if you break even?
Absolutely. Ultimately, businesses that don’t break even continue to lose money and eventually risk going out of business. That doesn’t mean you need to break even immediately, but it does mean that you need to keep track of your costs and expenses to make sure you’re staying on track.
This is especially important for brand-new startups. Businesses in their early days are always going to be expense-heavy because you have to pay for all the essentials. It’s like filling an empty kitchen—you’re not going to buy $40 olive oil every shopping trip, but the initial cost is going to hurt a bit. However, if you can track which costs are one-time purchases and which ones are repeated, you’ll be able to make a better estimate of future expenses.
Additionally, even if you’re not breaking even yet, just doing an analysis brings your business a slew of benefits including:
- Better pricing strategies
- Better expense tracking and missing-expense exposure
- More accurate numbers for investors
- Less financial strain under better business decisions
Let’s go back to Mary. If she knows that she’s only projected to sell 1,500 watermelons this year, what can she do? A smart businesswoman would examine all the variables to see where she can lower expenses and raise prices without detriment. Perhaps she can negotiate to lower her watermelon stand rent. Perhaps she can source watermelons from a cheaper farm, or cut down on her shipping costs by moving to a different company while raising her prices by 25 cents to stay competitive.
Essentially, your break-even point is the definition of “knowledge is power.” When you know exactly what you need to do to turn a profit, it’s infinitely easier to create an action plan. Otherwise, you end up with thousands of rotting watermelons, no customers, and no math equation that will be able to save you.
The scariest part of starting and running a small business is the fear of never making back your investments. But though those white water rapids of entrepreneurship may be tough, you don’t need to traverse them alone. Contact Know Your Numbers today for help managing your break-even point. Whether you’re a new business or an established business, we’ll jump in and paddle right alongside you.