What is Break-Even & why does it matter?

What is Break-Even & why does it matter?

Break-even as you may have guessed simply means the point at which all the revenues are equal to all the expenses. In effect you are making $0 and you are losing $0. So that was easy, why does it even matter? Good question. It matters because this is the magic number or analysis that lets you know how much you need to sell or do in order to cover all the costs. Let me explain.

This is helpful for the business as well as your personal life. It lets you know if you are going to make money or not during this period, whether that is a day, week, month or year. A business manager, leader or you individually can adjust or make better decisions if you have this number in mind.

First start with the last 90 days or 3 months of transactions. Pull out every single transaction or expense for the last 3 months, and categorize in broad categories. The categories I would suggest, or at least starting with, are as follows:

If you see that other is getting large, then break out another category that you have significant volume of transactions. The categories don’t matter as much and you can have as many as you like, just need a group to summarize the transactions. If you are paying monthly rent, you know to expect 3 rent payments over a 3 month period and same goes for utilities and loan payments. Once you have this summarized you have captured all expenses going out for a 3 month period. You can divide this by 3 to get a monthly average of expenses due.

Next up is the better side of the coin and that is revenue, sales or money coming in to you or your business. Same type exercise to perform here. The following categories are a good place to start:

This represents sales coming in over the past 90 days or 3 months. Take a quick peak, as I am sure some of you already have, and see if this number is higher than the expense number. If it is not, first make sure you have captured everything and next you probably need to make some changes. Again you can divide by 3 to get a monthly average for Sales or Revenue.

Now you have an average monthly revenue or cash coming in and an average monthly expense or cash going out, based on the last 3 months. Hopefully the sales side is higher, but we aren’t stopping here. The break-even amount is crucial for operations and a forward looking budget.

The fun part of the break-even exercise is next. Let’s lump the expenses into 3 categories. 1) Variable; 2) Fixed; 3) Semi-Fixed. Variable costs are those that are directly related to sales and increase or decrease along with sales volume. Think about raw materials, labor used to assemble products, etc. If business is slow and you aren’t’ selling products you shouldn’t have this costs – think of it that way. Fixed costs are the ones that don’t behave in this fashion. They are fixed in nature no matter how much you sell. Think about rent, insurance and loan payments. {Loan payments technically aren’t an “expense”, but that is for another post} As you probably guessed, Semi-fixed costs are a variation of the other 2 categories. These costs move a little but aren’t “directly” tied to production or services. Office supplies, travel, meals, and other would fill this category. This gives you 3 buckets of costs.

Now compare the revenue to the first bucket of variable costs and get a percentage of costs to revenue. Say costs is 60% of the revenue. This leaves you with 40% (Gross Profit) to cover the remaining costs. Add the remaining 2 buckets together and see if you still have enough money (the 40% in my example) left over to cover these costs.

For this post let’s assume that

“Sales – Cost of sales – Expenses = Net Income”

If that is true then how do we find the breakeven? Remember break-even is where Net Income is equal to $0. So then:

“Sales – Cost of sales – Expenses = $0” or “Sales – Cost of sales = Expenses”

If you have calculated the percentage that Cost of Sales is of your Revenue then you can plug in amounts to determine the breakeven. An example follows:

“Sales of $2,000 – Cost of Sales (60%) $1,200 = Expenses of $800” per month

In using this example we can divide by 4 weeks to get an average weekly sales number of $500 needed to break-even on average for the month.

Why is this important? This tells you that you need to have sales of at least $2,000 per month or $500 per week to break-even and anything above that converts to income. You can take the $500 down to a 5 day per week period and see you need sales of $100 per day to break-even. Therefore if you didn’t sell $100 today you will lose money unless you can make up for it on different days.

If you haven’t done this or it has been a while, I urge you to take the time and calculate your break even sales number. This is a powerful tool to gauge your business or your life.

Thanks for staying with me through the article!

As always reach out if you have questions, comments, or just want to talk. brent@brentmcclure.com or @LBMCPA on the socials.