Break-Even Analysis

A reader asked how to do a break-even analysis.

Here it goes.

Whether it is salaries for new employees, equipment, or both, starting a business or expanding production costs money.  Doing a break-even analysis will tell you how productive the expansion needs to be to pay for itself.

You need to know a few things to get your break even analysis to tell you the truth.

First, you need to know the cost of the expansion.  What will be the increase in the monthly cost of salaries, loan payments, and facilities?  How much will your fixed costs increase?

Second, you need to know your margins on your good or service.  That is, you need to know the cost of making the product (including sales and marketing costs).  This is your variable cost.

Third, you need to know what you can sell your product for.

A simple example will make this more clear.  Lets say you hire someone and take out a loan which cost a total of $5000 a month to expand your business (fixed costs).  Each unit averages $40 in expenses (variable costs).  You can sell your product or service for $50.  Your product could be a widget or an hour of consulting work.  It doesn’t really matter.

Your margin is $10 per unit.  So to break even you need ($5000/$10) units of sale or 500 monthly sales.  Actually, you don’t make any money in this scenario until the 501st sale, so part of your break-even analysis is a plan on how to exceed 600 or 1000 new sales per month with the expansion.

To make any growth strategy work more in your favor, you need to decrease the fixed costs where possible or make the increments of growth smaller.   So if you can grow with only a $2500 monthly increase in fixed costs but retain the other margins, you break even twice as fast.

And if there was a loan involved and you pay it back early, the lender will be much more eager to give you more loans.When a lender sees reliability, it decreases the cost of future growth.

See how effective business planning strategy can make you money now and in the future?

Tags: Business Development, Business Plan, Financial Planning, Strategy

This entry was posted on March 24, 2010 at 12:12 am and is filed under Business Plan, Three Rules. You can follow any responses to this entry through the RSS 2.0 feed.