- A break-even analysis helps you understand how many products or services you need to sell in order to turn a profit
- Conduct a break-even analysis when you want to determine if a business opportunity is viable or before launching a new product or service
- If your break-even point isn’t realistic for your business, consider adjusting your expenses or your sales price
When you start a small business, you need to make a lot of investments: finding the best brick-and-mortar, hiring a team that believes in your mission, and creating quality products and services. But as much as investments help your business grow, they can also be financial risks.The average small business launches with $30,000 in startup costs, which sometimes means taking out large loans or spending cash.
Being proactive about your business’ financial health can help you understand the risks you take on—and even minimize them as you grow. To understand what you need to do to turn a profit, learn how to conduct a break-even analysis with this guide.
What is a break-even analysis?
A break-even analysis tells you when your total sales revenue and total costs will be equal, which is also called the break-even point (BEP). When your business reaches the BEP, it means the business is no longer operating at a loss—and as long as your revenue continues to grow, it will be profitable.
A break-even analysis shows you exactly how much you need to sell in either units or dollars to cover your expenses each month. If the BEP doesn’t seem feasible, you’ll know you need to make changes to your pricing strategy or business plan to profit faster.
When should my small business conduct a break-even analysis?
Many small business owners conduct break-even analyses in the early stages of their business—sometimes, before they even launch. Early analysis can help you determine whether your business idea is profitable and if you’re pricing your products or services accurately.
However, break-even point analyses aren’t just for new businesses. This financial analysis is helpful for existing businesses that are launching a new product or service, expanding to a new location, or opening a new sales channel. The results will tell if an idea is worth your money and time as well as how much sales volume you need to ensure your cash flow stays positive.
For example, if you own a hair salon that mainly accepts walk-ins and phone appointments, you can conduct a break-even analysis to decide whether you should offer online bookings. Your break-even analysis will tell you the total sales dollars you need to earn from online bookings each month to cover additional costs, such as appointment booking software and hair stylists’ commissions.
Get a free Yelp Page
Promote your business to local customers.Claim your free page
Use these 3 steps to conduct a break-even analysis
You don’t need to be a financial pro to conduct a break-even analysis, just a break-even point formula. Follow this break-even analysis template to find the metrics needed to complete your calculations.
Once you know the total number of units you need to sell or total revenue you need to reach to break even, you’re ready to adjust your business strategy for success.
1. Calculate key metrics
Before you can calculate your break-even point, calculate the following four metrics that will plug into your BEP formula:
Total fixed costs
Your total fixed costs are the monthly expenses that stay the same, no matter how many goods you produce or services you provide. Not sure which costs are fixed costs? Think about it this way: Even if your sales volume dips from 1,000 units to 500 units in one month, you’re still required to cover these costs: rent, property taxes, business loan payments, software subscriptions, salaries, insurance payments, and more.
To calculate your total fixed costs for this first metric, make a list of all your set monthly costs and add them up.
Total variable costs per unit
Your variable costs are expenses that change with your sales volume. If your sales increase, your variable costs will increase; and if your sales drop, so do your variable costs.
These fluctuating expenses often include the cost of sales commissions, shipping, gas, credit card payment processing fees, and raw materials. Variable costs also include the cost of labor directly associated with the product or service. For example, a cleaning company’s variable costs might include the hourly wages of its professional cleaners.
To calculate your total variable costs per unit, add up all the expenses you need to cover to produce one unit or provide one service.
Sales price per unit
Your sales price per unit is the amount you charge for your product or service. If you’re analyzing more than one product or service, take the average of your sales prices.
If you haven’t decided on a price yet, research what your competitors are charging and how the value of your products or services compares. Your sales price should more than cover your production costs. For example, if your selling price is $10 and you sell 10 units, your total income is $100. If your production cost for those 5 units is $5 each, your total profit for those items is $75.
Don’t worry if you’re not confident in your selling price. One of the main reasons to do a break-even analysis is to determine if your current pricing strategy will be profitable. And you can always adjust your sales price per unit later if needed.
Contribution margin per unit
Your contribution margin per unit tells you how much each sale contributes to your total revenue. To calculate this metric, simply subtract your variable costs per unit from your sales price per unit.
If your contribution margin ratio is negative, it means your company is losing money with every unit produced or service provided. Increase your sales price and recalculate your contribution margin per unit before you begin your break-even point calculation.
Ready to try Yelp Ads?
Put your business in front of more customers.Start advertising
2. Use the break-even point formula
Once you’ve calculated your metrics, plug them into the following formula to calculate your break-even point in units:
Break-even point in units = total fixed costs ÷ contribution margin per unit
To illustrate the break-even point formula in action, let’s say your business has the following metrics:
Monthly fixed costs: $3,000
Variable costs per unit: $45
Sales price per unit: $75
Contribution margin: $75 – $45 = $30
Your break-even analysis would look like this:
Break-even point in units = $3,000 ÷ $30
Break-event point in units = 100 units
In other words, you’d need to sell 100 products or services each month before you can start making a profit.
If you want to calculate your break-even point in sales dollars, use this formula:
Break-even point in dollars = break-even point in units x sales price per unit
3. Strategize to reach your break-even point faster or increase your profit margin
If your break-even point is too high to realistically reach in your desired time frame, consider adjusting your strategy to decrease or increase your metrics. For example, can you lower your fixed costs by finding more affordable software? Is there a less expensive supplier you can work with to decrease your variable costs? You could also increase your sales price per unit to reach your break-even point faster each month.
Improving your pricing and/or production strategy can also help you increase your profit margin, which is the amount of revenue that exceeds what you owe toward expenses.
While not every business idea will be viable, calculating your BEP will help you determine potential profitability early on and what it will take for the business to be profitable.
Make smarter business decisions
Calculating your break-even point can help you make better financial decisions about your business. Whether you want to determine if a business idea is viable or if your pricing makes sense, a break-even analysis is an essential step toward turning a profit.
If you decide to pursue a new business idea after conducting your break-even analysis, ask yourself these six questions for starting a business.
The information above is provided for educational and informational purposes only. It is not intended to be a substitute for professional advice and may not be suitable for your circumstances. Unless stated otherwise, references to third-party links, services, or products do not constitute endorsement by Yelp.