Do You Know Your Breakeven Point?
Your breakeven point is one of the key facts that you must know about your business if you are to be a success. Surprisingly many businesses do not – they either have an incorrectly calculated one, an out of date one or they don’t even know what it is.
The Definition of a Breakeven Point
Your breakeven point is the amount of income needed to pay all your expenses, fixed and variable over a given period – usually your financial year. Income over that period must equal or exceed expenditure or your business is failing. The Micawber principle is one to always bear in mind.
‘Annual income 20 pounds, annual expenditure 19 pounds 19 shillings and six pence, result happiness. Annual income 20 pounds, annual expenditure 20 pounds ought and six, result misery. ‘ (Charles Dickens:- David Copperfield)
It is very balck and white – no ifs, no buts. If expenditure exceeds income, you have a problem so knowing exactly what your expenditure is and calculating your prices accordingly is critical.
Calculating Your Breakeven Point
On the face of it calculating your breakeven point should be simple. Breakeven is the point at which fixed costs divided by the contribution margin of each sales unit equals 1. What is the contribution margin – that is the amount left over when you subtract all the variable costs from the price of your product or service.
For example if you sell a product or service for £50 and it costs you £25 to produce or provide, then the contribution margin is £25. If your fixed costs are £500, then you need to sell 20 units to break even.
500 ÷ (25 x 20) = 1
It’s simple on the face of it, but those simple figures hide a multitude of variables, to name but a few :-
- Prices change
- Products go in and out of fashion
- How many hours of your services can you realistically expect to sell
- Depreciation of products if they hang around
- Suppliers want discounts
- Wages fluctuate
- Advertising costs
- Cost of sales
- Fixed costs fluctuate
Keeping track of these and ensuring that you adjust your pricing accordingly requires a good knowledge of your market and of how business costs change, such as changing tax rates – and what is included in those costs.
Many businesses fall into the twin traps of calculating their breakeven point when they start up and not revisiting it, or worse still calculating it on variable costs without taking into account the cost of doing business.
A good bookkeeper, who will have their finger on the pulse of changing costs and markets, is an invaluable tool in keeping you on track. Looking at past and future trends they will recalculate your breakeven point on a regular basis – at least once a quarter and maybe more often in volatile business conditions such as those caused by Brexit and the recent pandemic. They have the skills and knowledge to make a reliable judgement call on costs as well as realistic sales forecasts, helping to go beyond breakeven into profit.