Breakeven- When Will I Start Making Money?Posted by Celeste
An important calculation for an entrepreneur to make when doing their business planning is the breakeven point. Calculating breakeven requires accurate information, but is not particularly complicated. It can be a real eye opener for small business owners who love what they do but haven’t given much consideration to pricing.
Imagine for a moment that you are a purveyor of lemonade. Your lemonade stand has some costs associated with it. First of all there is the cost of lemons, sugar, and paper cups. If you sell a lot of lemonade, you spend more on these; if you sell only a little, then you spend less in this area.
Next you must consider your table rental (Wow, is your mom ever cheap!) your flyers, and the money that you pay the kid next door to watch your stand for you while you have lunch every day. These things cost you $10 every day, whether you sell 100 cups of lemonade or skunk out completely. These are your fixed costs. You know that you need to make at least this much in sales, but what about those other costs? They seem so variable – in fact, this is why they are called variable costs.
After much number crunching, your accountant tells you that your variable costs (lemons, sugar, and cups) work out to $0.25 per cup of lemonade. Now you need to set a price. If your price is $10.25 per cup of lemonade, then you only have to sell the one cup to reach your breakeven point and from there on out you are turning a profit. Well, alright, admittedly that is probably unworkable, but we will leave the setting your pricing discussion for another day. To be more realistic, let’s use the arbitrary price point of $1.25. You can see that you will make $1 on each cup after the variable costs are deducted. That leaves you $1, which is your unit contribution margin. It is easy to see that you will have to sell 10 cups to break even.
The formula that we use to express this calculation looks like this:
Breakeven Quotient= Fixed Costs / (Price-Variable Costs)
10 cups per day= $10 for table, flyers, and helper/($1.25 per cup price – $0.25 for lemon, sugar, and cup)
If it seems unlikely that you will be able to sell as many as 10 cups a day (your breakeven quotient) then you need to find a way to cut costs or raise prices. Perhaps you renegotiate that table rental agreement, bringing down your fixed costs, or perhaps you stop using organic lemons, bringing down your variable costs.
Have you calculated the breakeven point for your business? How did it change your business plan?