In business, making good decisions is often the difference between success and failure. Do you rely on gut, numbers or maybe a combination of both? There are a lot of tools to help, but one of my favorites is a breakeven analysis.
What is Breakeven Analysis?
Breakeven analysis is used to determine when you will be able to cover costs and begin to make a profit from your business investments. You may have used it when starting your business to determine how much sales or revenue you needed to cover your fixed costs or overhead.
It’s helpful before starting a business. It’s just as important as your business grows and projections are replaced with reality — actual numbers. But it’s also helpful when making decisions on a variety of issues – Should I:
- Invest in a marketing campaign, website or social media marketing?
- Hire additional staff to support our growth?
- Outsource a project or task to free up my time for important growth initiatives?
- Purchase a new piece of equipment?
- Upgrade our computers or phone systems?
- Invest in technology to support growth?
While ROI is often used for many of these decisions, you can also use a breakeven analysis to answer the question “When will I begin to make a profit from this investment”?
How to Calculate Breakeven
To do a break-even analysis, you need to know two things. First, the cost associated with your investment decision. Second, your gross profit margin (%).
To calculate the break-even revenue, divide the cost by the gross profit margin percentage. For example, if cost is $5,000 and your margin is 45%, your break-even revenue is $5,000 / .45 or $11,111. In this case, you will begin making a profit when you hit $11,111 in sales.
For help calculating gross margin, check out my blog post, Gross Margin: What You Need to Know to Avoid Disaster.
How Many Customers Do I Need?
Clients also find it helpful to look at the break-even point from a number of customers perspective. You can do this if you know (or calculate) the average dollar sale or transaction for your customers.
To determine the customer break-even number, simply divide the revenue break-even (above) by the average transaction amount. Example: If the average customer sale for the above business is $283, the customer break-even is $11,111 / $283 or 39.3 (40) customers.
Once you calculate the breakeven, it’s decision time. Here are a few questions to ask yourself:
- Is the breakeven reasonable and achievable based on the investment you are making?
- If the incremental sales include new customers, what is the potential lifetime value of these new customers? How does this impact your decision?
- How does this investment compare with past initiatives or others you may be considering now? Business is often about trade-offs and priorities.
Knowing when you can expect to see a profit can be a powerful decision-making tool. Use a break-even analysis to help you figure it out.
Ready to Put Your Business on the Path to Success?
Would working with a business coach help you take your business to a whole new level? Then let’s explore the possibilities with a complimentary consultation. It’s a chance to get to know each other, discuss your goals and the obstacles that hold you back. Together we can determine if there is a good fit between your needs and my services.
To learn more or schedule an appointment, call me at (856) 533-2344 or drop me an email Joan@HybridBizAdvisors.com