Break Even Education

Introduction – Break Even Education

OTHER Accounting Knols

1 Accounting Definitions   2 Debits and Credits   3 About me

 

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The answer to this question is of critical importance for a new venture as both the entrepreneur and the interested stakeholder needs to know the answer. You will be forgiven for not having a definitive answer to “How much money can you make?” because there is lots of blue-sky and unfounded assumptions included in that answer.

However, no one should start a business without; firstly knowing their break even point, secondly believing it 100% achievable and

• finally being able to defend and communicate that belief when required.

The Entrepreneur and Break Even

www.wordle.net Break Even Point Analysis

The main game for the entrepreneur should always be to get the new venture from launch status to financial sustainability. The break even point marks the point at which the new venture takes its first steps into the financially sustainable realm. It does not mean that you have recouped your losses to date, it simply marks the point at which you stop incurring them (losses).

Education about different Break Even Points

When evaluating an investment in a new venture there are three main break even points that may be considered. (1) Financial Break Even (2) Sustainable Break Even and (3) Equity Break Even.

Graph showing typical time lines to Break even

Financial break even is the revenue volume point where all external financial obligations are met. By external I mean those obligations that don’t include those of the equity (owners & investors) internal founders. At this point the new venture is not considered successful but it has at least been saved from being taken out of the game by external players.

Sustainable breakeven is the revenue volume point where all contributors to the venture’s income, including the founders, are appropriately compensated. This includes proper compensation for the founders time, market returns on equity investments made and proper ‘market-rate’ payments for any other contributions made to the venture. This is the minimum level that the entrepreneur should strive for in any new venture undertaking.  It is my opinion that, due to poor business modeling, fewer than 50% of all new ventures make it to this point with most falling somewhere between these two break even marks.

"Profit is the reward for delivering the appropriate service in the most efficient way" PB

Education about how to calculate a Break Even Point?

Simple … the break even formula for units looks like this:

Unit Break Even Point per month = (Fixed costs per month) ÷ (Unit $ Contribution Margin)

where

the Unit $ Contribution Margin  = (Unit selling price – Unit variable costs) or the excess of the selling price over the variable costs.

A

Accounting Glossary

It looks simple enough but unless you are an accountant, you probably don’t know what the terms fixed cost and variable cost mean. So let me explain.

Fixed costs per month are those costs you need to spend to maintain your business or product sales each month but which do not change in line with changes in your sales volume or business activity. Rent is a good illustration of a fixed cost. Regardless of how much you sell, the rent is still going to be the same. Other fixed costs could include equipment rental or lease arrangements, insurance, interest on debt, plant and equipment expenses, utilities, business licenses and salaries of permanent full-time workers.

Variable costs are those costs that do vary in line with and usually in direct proportion to changes in sales volume or business activity. Usually the largest and most common variable cost is the costs of buying or manufacturing the goods that are sold. This cost is often referred to as Cost of Goods Sold (COGS).  Other variable costs might include packaging, and labor directly involved in a company's manufacturing or sales process, vehicle fuel and salesperson’s telephone calls.

Steps to Calculating your Break Even Point

Step 1 – Formulate a monthly sales & costs profile

Try and look ahead to a monthly sales point at which you believe your business will be successful (usually in 1-2 years time) and picture all the types and probable amount of cost that would be associated with earning those sales. Now put these numbers in the following monthly worksheet. If they are yearly/annual costs then divide them by 12 to get a monthly equivalent. Examples are provided.

Step 2 – Calculate the contribution margin %

Divide the Total Variable Costs ($10,000) by the Monthly Sales $ ($20,000) to produce a percentage/contribution value. (10,000 ÷ 20,000) = 50% or 0.50

Step 3 – Calculate your Monthly Revenue Break Even (sustainable)

Monthly Revenue Break even = (Fixed Costs per month) ÷ (Contribution Margin %).

(7,000 ÷ 0.50) = $14,000. This means that given these assumptions, you would need to make $14,000 per month is sales to pay for all costs (both your variable costs and your fixed costs). Now take out of the costs those payments made to internal equity founders and then recalculate. This figure will give you your Monthly Revenue Break Even (financial) and the target you must get to or face failure.

Step 4 – Calculate the Customer Break Even Point

You will need to estimate, from your market research, what average $ sales amount your customers typically spend each time they purchase your products. You then divide this number into the Monthly Revenue Break Even amount to get the Customer Break Even Point. In the example given above, if the average customer spend was $14 per transaction then we would need ($14,000 ÷ $14) = 1,000 customer transactions per month to break even.

 

Step 5 – Develop your break even scenarios

Your current break even represents the most probable case. It may also be beneficial to calculate your best and worst case scenarios. Simply change the costs in the probable case to represent these views. Increase your costs to their highest likely levels to get worst case and reduce them to their lowest to get the best case. Recalculate. This gives you an overview of the full range of break even scenarios.

 Step 6 – Now ask yourself these questions and give yourself an honest answer.

Do I 100% believe that I can achieve this level of sales? Why?

"As I see it, to breakeven on life is to leave as we came – penniless" PB

                                                                                                                                            

Southbank Institute of Technology,  Australia