Knowing whether your small business is producing enough income to cover costs seems pretty straightforward, right? Not necessarily. If you don’t plan your income and expenses appropriately, you could have a nasty surprise. It’s good practice to perform a breakeven analysis to make sure your sales are covering your costs, or to work with an accounting professional to get it done.
Breakeven analysis is an approach to find the point at which you have enough sales to cover your production or service delivery costs and overhead. Knowing when you are selling enough to sustain your business involves more than looking at your bank balance; it starts with understanding and documenting your costs.
Know Your Costs
Documenting all the costs of doing business should be part of budgeting and pricing your product. If you haven’t documented all your costs yet, this is the time to do it, or to see the aforementioned accounting professional.
For a breakeven analysis, your costs fall into one of two types: variable costs and fixed costs. A variable cost changes when the level of production or service delivery changes. Typical examples include materials and supplies. Fixed costs do not vary depending on the production level, such as rent, insurance, and other overhead expenses.
Some costs are not as clear to categorize. Compensation is typically a fixed cost, unless it is paid as a commission tied to production. Utilities are generally a fixed cost, however, if it is possible to effectively monitor the electricity used by machines in production, utilities could become a variable cost.
Breakeven Sales Point
First, determine your contribution margin, the amount that each sale “contributes” to covering fixed costs. It is calculated by dividing the total fixed cost by the price minus the variable costs. For example, a business with $50,000 in fixed costs that sells a product for $15 with $10 in variable costs has a contribution margin of $5. This means that 10,000 products sold will cover fixed costs. Fixed costs are covered with the 10,001st sale.
Small businesses need to know their costs and understand their breakeven point to avoid nasty financial surprises. For assistance, consult your accounting professional.