Break-even: the magic word
What does really mean break-even? It is the level at which the company makes neither a loss nor a profit, but just covers it’s fixed costs or overheads. It’s the floating point, at which you know that you are not sinking. In practical terms it could be the level of monthly sales that, once reached, will give you the security of paying your bills, at least for that month. Or for a whole year. Or even how many units you need to sell in order to cover all the fixed cost, to pay all your bills.
That’s really important, isn’t it? It is the sales target you and your staff staff must reach every month, as each sale after that generates profit, even at a deep discount.
There is no need to panic: its very simple to determine your break-even point. First of all we must understand three things: variable costs, fixed costs and revenue.
Variable costs are the costs of goods sold, that is they are expenses which change in proportion of the activity of a business. They may include the cost of raw materials, or of the items you sell, if you are a re-seller. Payroll expenses which are directly related to the objects or services you sell are also variable costs, because they go along with the level of revenue. Salaries of admin staff, which you have to pay regardless of how much you sell, are instead fixed costs.
Fixed costs or overheads do not change with the level of business activity, or sales. They are the bills that you have to pay every month, no way out, whether your sales are good or bad.
The revenue is your total sales, total income. The relationship between these three components is what determines the break-even point. Revenue minus the variable costs gives your gross profit. Gross profit minus overheads is your net profit, or EBIT, or even EBITDA if you wish to sound more sophisticated. (Earnings Before Interest and Taxes-Earnings Before Interest, Taxes, Depreciation and Amortization).
These are thick words but the meaning is simple. Now, how do I get to know when I reach the break-even point in my sales? That is, how much revenue I must generate at least to pay my bills? Here is the formula
OVERHEADS divided by GROSS PROFITS times REVENUE=BREAK-EVEN
Easy, isn’t it? If you wish to calculate your monthly break-even, you must take an average of at least the last six months.
In a downturn economy is obviously so important to constantly monitor our business, and to know our break-even point is essential.
