WHY IS IT SO IMPORTANT FOR BUSINESS OWNERS TO KNOW THE BREAK EVEN NUMBERS OF THEIR BUSINESSES?

For the sake of simplicity and to make it easier to understand the definitions explained below may not 100% satisfy the Chartered Accountant or Director of Finance amongst us but it is sufficient for the purpose of helping the business owner without a financial background to understand it. In order to understand the break even analysis of a business you need to understand the definitions and calculations here below.

1. What are Cost of sales or variable expenses: These are the expenses that are directly related to the number of products (units) produced or the number of services rendered. The more units produced or services rendered the bigger this number become. Typical examples will be that the business will use more parts to produce more products or will use more hours of labour to render more services.
2. What are fixed expenses: These are the expenses that do not change as your volume of products or services change. A good example is the rent that the business pays. This does not generally change as you produce more or less products or services. It will change if the business does become so busy that it needs a bigger premises but that is not directly linked to each and every product or service delivered.
3. Costing products and services: This is done by accurately calculating the cost of the different steps and parts used to manufacture a product or to render a service.
4. Markup: This is the percentage with which you increase your cost price of the product or service to calculate your selling price. Example: the product cost $200 your selling price is $250. Your markup is ((Selling price - cost price)/cost price) x 100 = Markup% ... (($250-$200)/$200)x100=25%
5. Gross profit: Is calculated by deducting the cost of sales (variable expenses) from the sales.
6. What is profit: Profit is calculated by deducting all fixed expenses from the gross profit.
7. What is break even: This is when the business knows exactly how many products or services it needs to sell to cover the cost of manufacturing the products or to render the services as well as all the fixed expenses. The business therefore does not make any profit or loss at its break even point.
8. Why is it important to know your break even: This is a very important figure for the business owner to know for a number of reasons. To name a few. Once the business owner knows how many units or services the business needs to sell to break even he can then also calculate how many products or services does he need to sell to make the profit he or she wants to make. The business owner can now also determine whether it is possible for the business to do that with the infrastructure and resources available. Another very important reason for knowing the break even is that once the business has reached its break even point for the month. Every sale made for the rest of that month will then only have to cover the cost of sales(variable costs) per product or service the rest of the selling price will go straight to the bottom line (profit) because all fixed expenses will be covered when the break even point is reached!!   
9. How do you calculate your business' breakeven: Here is the formula. Break even = Fixed Costs/(selling price - cost of sales(variable costs). Example. Your business' fixed costs are $10 000 the product sells at $100 and your Cost of sales(variable costs) are $40. How many product units do you need to sell to break even.  $10000/($100-$40) =166.7 rounded to167 units. From product unit 168 and onward sold in a month your business will be making $60 dollar profit with every unit sold. So if you need to make $5000 profit per month that means you need to sell 167 + ($5000/$60)83.3 = 250 product units. Now that is a very important number to know for a business owner. This is a simplified example to explain the concept. In real life it becomes a bit more complicated as there are usually more than one product or service involved, mark up may differ between products or services etc. The point is that as a business owner you need to understand break even and know how to do t for your business.

If you need further assistance or help with doing a break even analysis for your business Contact Us so that we can assist you.