Breakeven analysis seems to be one of the areas that small company owners in particular don’t spend as much time on as they ought to. This blog is going to try to find out how it can be an area of improvement for companies. We will address the questions below.
So, what exactly is a breakeven analysis?
Why is it so important?
What would be the benefits of completing one?
To begin with; what exactly is breakeven analysis – it’s an important, though underused, business tool. It is used to help companies to determine the level of profitability – especially useful if you use it together with a projection strategy. This tool is used across all industries to initially find out your FIXED COSTS. Why would you be doing this? It is paramount that you fully understand what your business is costing you to run. The product; service; programmes that you provide to your customers are NOT important at this stage. You EXPECT to be making a profit from your products; services or programmes otherwise you will definitely NOT succeed in business.
The way I explain the situation to all my clients is this
How much do you have to earn on the 1st of every month for you to start making a profit? In other words, what are the monthly fixed costs for your business?
How do you work that out
You simply create a table which will contain all of the costs that you are paying related to the company; either monthly or annually.So let’s look at some examples that are pretty generic.
If vehicles are part of the business and you are making monthly payments; then they must go into this table; (also be aware that cars do depreciate so the depreciation should appear in the annual column as a fixed cost too).
In this day and age; businesses will have many technical devices that are leased or rented. If this is the case with your business, then they must appear in this table. HOWEVER; if you have purchased these devices outright; they are NOT part of your fixed costs. Examples here are landline; mobile phones; printers in the office; computers and so on.
All fixed costs associated with this aspect of your business once again must appear in the table. Again; if you have paid outright for the development of your website this cost will not appear. Hosting; monthly payment for social media traffic are costs that you must put into the table.
The costs for your officeconsumables are also fixed costs. Paper you purchase to use for printing; stamps for sending letters; printer cartridges; envelopes; pens and pencils and so on.
In some cases; businesses rent the furniture for their office space – if so it is a fixed cost.
If you are renting or leasing your office this is also a fixed cost and needs to be included. If you happen to have a business where you need extra buildings [due to number of staff or warehouses if storing material or you arein the trades] then these also are part of this table. In all the buildings that you use, there will be utility bills to consider.
Will be included as a fixed cost.
I am sure you will be paying an accountant either a monthly or annual fee and may have legal representative associated with the business. You may also have sub-contractors on the books or external consultants. These examples are all fixed costs (unless your staff is on commission) and should appear in your table.
You should know your organisational chart and your planned manpower, therefore your salary section should be easy to complete.
If you are starting off your business; it is very tempting to guess at what these fixed costs might be. This could turn out to be a costly mistake as you may think that the target figure is far lower than it actually is – how easy in those circumstances would it be for one to relax a little thinking that you are now in profit territory? So do try to have the fixed costs as precise as possible.Every business will have some extra over and above what we have discussed to date – you must make sure you add everything in.
Now would be the time for you to multiply the monthly costing by twelve and put that amount in the total column along with the annual costings. Now add up the total column for your annual breakeven; divide by twelve and you have your monthly fixed cost breakeven.
There will be some areas of the business that are costs for running your business (in other words not bringing in any profit) which you have not been able to include above as the cost may vary from month to month or time to time. This is known as VARIABLE COSTINGS.
Tax and insurances – this is an area that will be a variable cost. It’s another area that you may not be able to be precise initially but need to be taken into account along with bank charges. Your accountant should be able to help ensure you have a good picture of what these costs will be for your business.
Other variable costings would include COMMISSIONS for the staff – you would not know what these would be up front; so again either target projections or historical evidence would help you to decide what to put down.
In some cases there may be maintenance and repair costs which come down to you. If so, these are variable costs and you would need to determine with your accountant what to have in the table.
Advertising and marketingis another area that may be a variable cost unless you have a dedicated monthly sum for an external company to do it for you.
Travelling and accommodation –unless you are invoicing your clients for this it becomes a variable cost. A very simple example is if you are networking – this is part of building up your business; you are travelling back and fore to the network event/s and should you be staying overnight this cost is down to your business. How many times in a month/year are you likely to be doing this? This needs to be part of your costings.
Now that you have an understanding of your fixed costs; an idea of your variable costs; adding these figures together will help you to know how much your business is costing you to run. As a result, you can now use this information for the final part – that of PRICING your product/service or programme.
It’s only at this stage that you will know what you must sell your goods for [and how many units] to make a profit within the business.
You should know the COST of getting your product; services or programmes onto the shelf (this is known as UNIT COSTS); so by adding UNIT COSTS to the ANNUAL FIXED AND VARIABLE COST you now know how much you need to earn throughout the year to start making a profit. Divide this NEW TOTAL by twelve and you will have the monthly figure required for your UNIT PRICE TO BREAK EVEN. Decide what % above your BREAKEVEN you want; and that becomes your PROFIT MARGIN.
Hopefully, we now have a better idea of what a breakeven analysis is; how to conduct one; the importance to the business and the benefits of completing one.
Co-Founder and Co-Director Business Growth (International) Ltd.