The break-even point for your business is the point at which your total costs and total revenues are equal, indicating there is neither a loss nor a profit. In other words, you have identified the point at which the cost of producing and/or delivering your product, service, or solution is equivalent to the revenue it generates.
This is an essential computation.
When starting a business, you will want to know the expected return on your and others' investments, as well as the point at which this return will be realized.
It may be the case that you do not expect your business to generate a profit in the first few months or years; therefore, it is crucial to know the break-even point, when things will begin to change, especially if you are pursuing outside investors.
Existing businesses use this tool to analyze costs and evaluate the profits they will achieve at various sales volumes. In a potential turnaround, it is also the point they will strive for.
A break-even analysis determines the point at which a business, product, service, or solution becomes profitable. In other words, it is a financial calculation used to determine how many products or services must be sold to cover production costs.
The break-even theory is founded on the straightforward fact that there is a minimum quantity of a product at which a business incurs neither profit nor loss.
When you break even, you are neither losing nor gaining money, but you have covered all of your expenses.
A break-even analysis could help you determine, for instance, how many products you must sell to cover your warehousing expenses. Or how many hours of a service must be sold to cover the cost of the office space.
Anything sold in excess of your break-even point will generate a profit.
To comprehend break-even, you must also comprehend that there are two types of expenses.
Fixed costs: expenses that remain constant regardless of sales volume, such as rent and administrative fees.
Variable costs: expenditures that vary with production or sales volume - production costs and commissions
The break-even point is crucial for business proprietors because it indicates the minimum level of sales required to generate a profit. If a business proprietor is aware of the break-even point, they can make educated decisions regarding pricing, production levels, and other variables that affect their bottom line.
Knowing your break-even point can assist you in making decisions regarding the relocation of your business, the purchase of a new computer, the hiring of a new employee, or any other expenditure. You may be uncertain as to whether you can afford to make a purchase, but you now know exactly how much more of your product or service you will need to sell in order to reach break-even and maintain your forward momentum. Knowing your break-even point also means you know how much more you need to sell in order to make a profit, and if your business is truly struggling, it can help you determine where to reduce costs in order to stay afloat.
Consider a solar heating engineer company that calculates their break-even point; they now also know:
If they perform fewer than 30 installations per month (at a cost of $10,000 plus $3,000 for materials), they will incur a loss, and if this trend continues, they will inevitably fail.
If they perform exactly 30 installations (at $10,000 with $3,000 material costs) each month, the business can continue to exist, but they will never make a profit.
If they perform more than 30 installations (at $10,000 with $3,000 material costs), they will make an average of $7,000 profit for each installation over 30.
This information is essential for the financial planning of your business, as without it you will not know what your sales goals should be or if you need additional funding to fund your growth.
With this straightforward piece of information, the business knows everything it needs to know about the sales it requires and how the cost of marketing and advertising drops as a percentage of sales above 30 monthly installations.
Now, the owner only needs to count how many jobs there are to know how the business is doing financially.