March 2, 2019
Kindra K., Marketing Coordinator
Starting a new business isn’t for the faint of heart… or for the impatient. In fact, most new businesses aren’t profitable for about three years. But just because you’re not raking in piles of cash doesn’t mean you have to be bleeding it. The first goal toward turning a profit is breaking even. It may not sound as exciting as a free trip to Hawaii, but the moment you break even is actually a big milestone for your business.
Put plainly, your breaking even point (BEP) is when your sales are exactly covering your expenses. But calculating the BEP isn’t as simple as it sounds. You must take into account all of your expenditures, both fixed and variable, and do some calculations about profit per unit. Here is a 4-step plan for how to calculate the break even point for your business.
The fixed costs are the easiest part of your break even point calculation. These are the expenses that remain predictable each month/period. That being said, it’s easy to leave something out of your calculations if you’re not careful. Here is a list of common expenses that will comprise your fixed costs:
Rent. The costs associated with leasing your office, warehouse, and/or retail spaces makes up a huge percentage of your fixed costs.
Salaries. Executive salaries are likely to remain fixed for the first few years of operation.
Property taxes. If you own any property associated with your business, don’t forget to factor in these annual taxes.
Depreciation of assets. The depreciation of an asset, from a vehicle to a building, is also considered a fixed cost.
Insurance. Regular insurance payments are unlikely to fluctuate significantly from month to month, so put them in the fixed cost category.
The next step is to itemize the retail price of each product or service your business offers. This may change as you determine your target profit formula, but you need to get a baseline. For instance, maybe you run a business selling sunglasses and hats. The current sales price of a pair of sunglasses is $5 and the price of a hat is $10. This information is crucial to calculating your break even point.
On to the variable costs. These are the costs associated with actually producing your sunglasses and hats. Variable costs change in proportion to your production volume. If you produce fewer sunglasses this month than last, your variable costs will also decrease. Variable costs are typically calculated on a per unit basis. Some examples of variable costs include:
Labor costs. As you produce more sunglasses and hats, your factory labor costs will increase. If you have a retail location, you may also need more employees to handle the increased sales.
Raw materials. Let’s say your sunglasses are made of plastic and metal. As you produce more sunglasses, you’ll need to buy plastic and metal in larger quantities.
Sales commissions. If you have employees on a commission schedule for selling your sunglasses and hats, you must also consider the average commission per unit.
Packaging. Just as your raw material costs fluctuate depending on production needs, your packaging costs will also go up and down based on the number of units you sell.
Now you have all of the necessary elements on hand to calculate a break even point. The basic formula is: Fixed Costs / (Price - Variable Costs). The second part of the equation is also called the contribution margin because it represents the dollar amount each unit contributes toward fixed costs.
When you’re considering multiple products in your evaluation, you’ll also want to weight the selling price and variable costs accordingly. For instance, maybe your annual sales break down to 40% sunglasses and 60% hats. Let’s use these numbers in a break even point example to show you how this formula is done.
Say your fixed costs (rent, salaries, insurance, etc.) are $100,000 per year. The price of your units, as we referenced earlier, is $5 for sunglasses and $10 for hats. Now let’s say your variable costs (materials, factory labor, etc.) break down to $2/unit for sunglasses and $4/unit for hats. Remember we’re assuming your sales are 40% sunglasses and 60% hats.
To figure out the weighted selling price, you will multiple the sales price of each product with its contribution to overall sales:
= ($5 x 40%) + ($10 x 60%)
= ($2) + ($6)
Now let’s calculate the variable costs using a similar weighted formula:
= ($2 x 40%) + ($4 x 60%)
= ($0.8) + ($2.4)
Now you’re ready to run your break even point calculations
Fixed Costs / (Weighted Price - Weighted Variable Costs).
$100,000 / ($8 - $3.20) = 20,833 units
Your company needs to sell 20,833 units per year to break even, but let’s see how that breaks down among different types of product given that you sell more hats than sunglasses.
20,833 x 40% = 8,333 sunglasses sold
20,833 x 60% = 12,500 hats sold
You need to sell 8,333 sunglasses and 12,500 hats this year to break even. Or, if you’re offering services, you need to book 8,333 sunglasses jobs this year and 12,500 hats services.
Once you have a break even point based on sales, you can start to outline how long it may take you to actually reach that goal. For instance, if you know it will take 18 months to sell that many sunglasses and hats, you can make the BEP a second year goal.
Figuring out the break even point for your business is a crucial step toward profitability. It’s near impossible to meet financial goals without detailed accounting practices, as any new business owner will soon discover. To that end, your business should be taking advantage of Housecall Pro’s QuickBooks integration and invoicing software whenever possible. Are you ready to take control of your business finances and break even? Contact Housecall Pro to learn more about streamlined scheduling and payments for your home services.
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