Getting to break even is the first step toward profitability. The calculations aren't difficult: If you can accurately forecast costs and sales, a breakeven analysis is a matter of simple math. You've broken even when your total sales or revenues equal your total expenses.
First, we'll define what comprises costs. The most important terms are "fixed" and "variable" costs:
- Fixed costs. These are costs that are the same regardless of how many items you sell. All start-up costs, such as rent, insurance, and computers, are considered fixed costs since you have to make these outlays before you sell your first item.
- Variable costs. These are recurring costs that you absorb with each unit you sell. For example, if you were operating a greeting card store where you had to buy greeting cards from a stationary company for $1 each, then that dollar represents a variable cost. As your business and sales grow, you can begin appropriating labor and other items as variable costs if it makes sense for your industry.
As far as revenues go, for the purposes of calculating breakeven, it's typically documented in terms of unit pricing, which refers to the amount you plan to charge customers to buy a single unit of your product. To get to a unit cost, it may help to define a couple of common methods for overall pricing; (there are many, but these are the most prevalent):
- Cost-based pricing calls for figuring out how much it will cost to produce one unit of an item and setting the price to that amount, plus a predetermined profit margin.
- Price-based costing, a term coined by David G. Bakken, author of The Customer Knowledge Advantage blog, starts "with the price that consumers are willing to pay (when they have competitive alternatives), and whittle down costs to meet that price," he explains. That way if you encounter new competition, you can lower your price and still turn a profit.
(This About.com article offers an overview of common pricing methods.)
Once you have a handle on costs and revenues as defined above, the breakeven formula is fairly simple: Take your fixed costs, divided by your price, minus your variable costs. If you prefer to view it as an equation, it's defined as: Breakeven Point = Fixed Costs/(Unit Selling Price - Variable Costs).
Source: How to Do a Break-even Analysis, About.com Entrepreneurs
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