John Brian Fast, CPA

What do you need to do to pass the break-even point for your business?  A break-even analysis indicates at what point your total costs and your total revenues are equal.  The term break-even implies that point at which the company neither makes a profit nor suffers a loss.

The first step in break-even analysis is to determine the fixed and variable components of your costs.  For example, rent lease payments are a fixed commitment for a contractual period of time and are usually the same from month to month.  An example of a variable expense would be a percentage commission paid to salesperson based on his or her sales.

Revenues are usually variable.  For each unit sold revenues are increased by the amount of the sale.

To determine your break-even point:

1.     Determine a time period for your analysis (month, quarter, year, etc.)

2.     Estimate the sales revenues per unit over the time period to be evaluated.

3.     Determine the total fixed costs to be incurred during the period.

4.     Estimate the variable cost per unit sold.

A break-even chart is effective because it is a visual, compact, easily readable graphic reporting device.  The key variables for breaking even are readily apparent.

In the break-even chart above the fixed costs for the quarter are estimated to be $ 40,000.  They are charted on the bottom of the chart with the red line.  The variable cost for producing and selling each unit is $ 50 per unit.  The variable costs are charted with a brown line above the fixed costs and are calculated by multiplying the units sold by $ 50.  The sales price per unit is $ 100 per unit.  Revenues are charted using the green line.

The break-even chart indicates that the break-even point for the unit in this simple example is 800 units.  The variable contribution for each sale is $ 50 (variable sales price minus the variable production and sales costs.)  To cover the fixed costs of $ 40,000, it requires 800 units to be sold (800 units times the variable contribution of $ 50 per unit equals $ 40,000.)

The key to effective break-even analysis is the accuracy of the underlying information and the reasonableness of any assumptions made in the analysis.  The source of the underlying data and the assumptions should be clearly understood and as factual as possible.  Kidding yourself about the true economic environment in which you operate is not helpful.  A good business manager allows a fudge factor for contingencies. 

Recommendation:  Be conservative in estimating your revenues.  Recognize and acknowledge the worst case potential for your expenses.  Construct a break-even chart to easily understand the elements that determine your break-even point.  The key is to have a knowledgeable and realistic understanding about what is really important for your business.

This is an update of a post previously published on August 12 and December 7, 2009.