Breakeven analysis and profit – basic tips for startups

Even before a business is launched, and certainly after, you should have a clear outline of breakeven points in order to calculate pricing and keep track of profitability. These tips get you started.

29th December 2008 at 11:38 pm

If you’re writing a business plan, or launching a new product or service, a real understanding of what it’s going to take to turn a profit is vital.  The breakeven analysis is one of the most important basic financial tools at your disposal.  Here’s how it works:

  1. The basic maths you need to calculate a breakeven point are as follows: fixed costs / (sales income – variable costs).  Equivalent to fixed costs divided by gross profit margin.
  2. What are fixed costs (FC)?  Typically these are costs which aren’t going to change significantly month to month i.e. rent, staff salaries, insurance, utility bills etc.  All the things you’d have to pay regardless of how much you were selling.
  3. Sales income (SI) is simply the total amount of money received from sales to customers.
  4. Variable costs (VC) are those linked to the sale of goods or services.  For example, if you’re selling an educational course delivered on DVDs the cost of producing these products will vary depending on how many you need to produce to meet demand.  Taking on extra staff on a temporary basis to deal with peaks in demand could also be included as a variable cost.
  5. Gross profit is simply sales income minus variable costs, while the gross profit margin is the percentage of total sales left after subtracting variable costs.
  6. By way of example, if your educational courses cost £40,000 a year to produce (FC), your variable costs were £0.50 per DVD, £5.00 labour per DVD and £0.50 overhead per DVD (VC), then at a selling price of £49.99 per DVD course your breakeven point would be £40,000 /  (£29.99 – £6.00) = 1,667 units.
  7. But breakeven, while useful, has its problems.  Are fixed costs ever really fixed?  And the sums only ever help assess costs, not real potential sales.  Best to do a forward projection break-even, followed by a breakeven calculation using your real profit and loss figures for a set period.

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Alex is the founder and editor of SmallBizPod and BizPod Media Ltd. He is passionate about startups, small businesses and their inspiring stories. He's also a firm believer in the power of SMEs and entrepreneurs to change the world.

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