Whether you are looking to start a new company or expand your current business, knowing when your business will cover its start-up costs or the expense of implementing a new infrastructure is crucial to your long-term plan.
Once a business is aware of how long they will need to cover their expenditure, and what they need to aim for with sales and stock figures during this time, they can plan accordingly. Without the insight of a break-even point, a business could succeed or fail. Read on to discover how you can use the break-even point formula and BEP analysis to help improve your business’s longevity.
Break-Even Point: What Is The BEP And Why Is It Important?
The point a business breaks even, when they are operating with neither a net gain nor net loss, is identified as the break-even point (BEP). The level of output a company needs to produce the necessary revenue to meet its total expenditure can be determined with the break-even point formula, allowing businesses to plan and estimate when they will begin to generate pure profit.
When a business surpasses its break-even point, this achievement can be seen as a sign of a healthy growth rate. Once the incoming revenue matches a business’s costs and covers the amount of any business loans taken, your company is seen to be doing well. Companies that fail to achieve a profit will eventually run out of money, deeming the rest of its operations unsustainable. With knowledge of the break-even point, it is possible to set manageable revenue targets in line with the business strategy, allowing this to evolve to reflect the BEP analysis.
With your company’s finances levelling out and your business actually making money, your business should be financially stable. This stability allows you to push forward and plan for your next period of growth or simply tick over with healthy profit margins. However, to get to this more comfortable position, it is paramount that you know how to conduct a break-even analysis. With an understanding of when you will reach your break-even point, you can determine influencing factors such as fixed costs and variable costs to work out your potential margins. Overall, this allows you to forecast a clear path towards profitability.
The first step to understanding and implementing this plan is calculating your business’s break-even point.
How Do Businesses Calculate Their Break-Even Point
The exact point a company’s revenue equals its outgoing costs can be determined with the break-even point formula. If you’re concerned about how to work out the break-even point, there are one of two ways to make this calculation. The first is to work out how many units need to be sold, and the second is the amount of money that needs to be generated from these sales in GBP.
Break-Even Point Formulas
- Break-Even Point (no. of units) = Fixed Costs / (Revenue Per Unit – Variable Cost Per Unit)
OR
- Break-Even Point (Sales in GBP) = Fixed Costs / Contribution Margin (£)
Whereby, contribution margin = Price of Product – Variable Costs
In its simplest form, the break-even formula allows companies to find out when their product will start making a profit. It allows for all the manufacturing processes to be taken into consideration alongside costs associated with inventory, labour, and even rent while providing an insight into how much money this unit could make as well as how much it is currently costing you.
With the outcome of the break-point formula, it is possible to evaluate just how sustainable business is from your current range of products and whether they are pitched at the correct profit margins. And, ultimately, once your business reaches this point, all revenue beyond this point contributes to the accumulation of NET profit.
Components Influencing The BEP Formula
When it comes to carrying out these calculations with the BEP formula, there are several components that are also considered. These factors can influence the results of the break-even formula, both directly and indirectly. However, in order to achieve a more favourable break-even point, it may prove worthwhile to investigate these factors and see if any savings or prices can be amended.
Fixed Costs
Your total fixed costs play a crucial part in the break-even point formula, directly impacting how long it will take your business to match and exceed its outgoings. Fixed costs are completely separate from the number of sales you’ll require to turn over a profit. Instead, they take into account how much you are paying on rent, storefront and any production facilities, it should even include the cost of any technology and software that is required. Another outlet that is considered is PR, advertising and design work.
Variable Costs
Variable costs instead cover a business’s outgoings that can fluctuate month on month. These include the company’s expenditure on wages, utilities and materials needed and used in production. For example, as inventory costs fluctuate, so will the benchmark approximate within your break-even point formula.
Contribution Margin
A contribution margin takes into consideration how much it costs to create one unit/product. For example, you may have a product that retails for £50. However, with the cost of the initial raw material and production process, your company has to pay £10 to manufacture each product. Therefore, your contribution margin is £40, and this is used to cover your fixed costs. Anything above this is considered your net profit.
Contribution Margin Ratio
Often expressed as a percentage, the contribution margin ratio is calculated by taking away the total of your fixed costs from your contribution margin. In doing so, this allows a company to assess whether or not they need to cut production costs or increase the retail price of their product.
Profit Following A Break-Even
When your fixed and variable costs are met by the number of your sales, your business reaches its break-even point. A business will then record a net profit of £0 at this point, any sales after the BEP has been reached will contribute to your net profit pot.
Analysing Your Business’s Break-Even Point
Using the break-even point formula to produce a BEP figure is only half the job. To put these results into action, it is necessary to carry out a break-even analysis. Calculating your business’s break-even point and carrying out a break-even analysis will only benefit your business in the long run.
What Is Break-Even Analysis?
Break-even analysis is the process of putting your BEP calculations into action. It allows businesses to delve into what their figures mean in relation to the business’s growth and sustainability. When analysed in detail, the BEP can be used to plan ahead, establishing logical sales goals and targets with achievable product prices. However, it is also possible to revolutionise a current business model allowing for self-reflection and improvements to be implemented. Once the break-even point is known and understood, there are sales tactics and marketing strategies that can be enforced to increase the time it will take to grow a net profit.
It is worth noting that there is no guarantee you will hit the sales figures you need to break even. They can be a benchmark for you to aim for, but they must remain under constant review alongside the state of the overall market.
Why Is The BEP Important To Businesses?
In already established companies, a break-even point can be calculated on a smaller scale. This form of analysis can allow a company with a diverse portfolio of products and services to carry out a product-level investigation, helping them to determine which products are more economical than others.
By carrying out an in-depth survey into how each product is performing and how each unit must perform to cover the business’s fixed and variable costs, it is possible to anticipate the losses and profits the company will face. Knowing these fluctuations in advance allow your company to stay one step ahead and reactive to your business’s peaks and troughs.
Knowing your break-even point also lends itself to streamlining other areas of your business. For example, your BEP plays a crucial role in calculating and understanding your minimum order quantity (MOQ).
On the whole, however, there are five key areas where the break-even point and break-even analysis can be used to benefit daily planning and operations: prices, materials, new products, planning and targets.
Prices
After completing your break-even analysis, it may become apparent that your product costs are too low. When this is the case, the time it will take to break even will take significantly longer. In these instances, your desired timeline becomes unachievable and your company will be operating at a net loss for too long. However, before inflating your product prices, it is important to take competitors into consideration. You want to avoid pricing yourself out of the market by focusing too much on reaching your BEP quickly.
Materials
After investigating how much money your company is spending on fixed and variable costs, you may discover that you are wasting capital on inventory and unsustainable labour costs. By implementing new measures and negotiating new contracts, it may be possible to streamline your costs in this area. For example, the way your company stores its inventory may be draining your budget. By exploring fulfilment centres, it may be possible to cut labour and warehousing costs, allowing you to achieve your BEP sooner.
New Products
When a business looks to develop and launch a new range of products, it is recommended that they reassess their fixed and variable costs. In doing so these can be considered when deciding the costs of the new unit and what grade of inventory can be used. For new products, in particular, a marketing budget must be established in advance and incorporated into the break-even point calculations.
Planning
As your business grows and develops, you may consider expanding your company’s reach, moving into a new operational direction, or pushing a wider range of products and services. No matter what your longer-term goals are, it is important you understand the consequences of your plans. For example, by expanding you will need to upgrade your premises to a larger office space, as this will come with a higher price tag. By referring back to an updated BEP calculation, you will know your new targets based on more outgoings.
Targets
Once a company reaches its break-even point and begins to build up its net profit, your team can be inspired to push forward. This burst of motivation can be nurtured and pushed further across the business, allowing you to continue along an upward trajectory.
Understanding Your BEP
Whether you are creating your own start-up or looking to improve and develop an existing company, understanding your break-even point can help you keep your expectations realistic. By referring back to your BEP figure and this means from your break-even analysis, every decision you make is grounded in realism; you should always know how long it will take you to generate a net profit and how the current ongoing costs of setting up the company or launching a new product will be managed.
In short, knowing and analysing your break-even point allows your company to have a business strategy that has realistic and sustainable targets. All you need to do is monitor these goals in line with the day-to-day market and customer fluctuations.
Aligning Your Break-Even Point With Inventory Management
As your business progresses towards your break-even point and beyond, it is important to keep your inventory management and warehousing in line with your current scale. Inventory management can be an overwhelming task; however, by gradually growing your inventory supply and stock to match your current operations, you can keep your fixed and variable costs down.
Rather than struggling alone with your logistics, storage and inventory order fulfilment, let us help with your inventory management. At Breakwells, we have over 50 years of experience providing reliable support across all aspects of inventory transport and storage. We offer flexible solutions to meet your ever-changing needs. Contact us today for more information.