How do I work out my break even point and does it even matter?
In its simplest terms, a break even point is reached when your total revenue matches your business costs and your business is not making either a profit or a loss. Anything generated above this point is a profit.
In my experience, many business owners, particularly if they are early in their business journey, consider ‘breaking even’ to be a cause of celebration. In some cases, it is actually a business goal.
But, as a measurement, benchmark or goal, does a break even point even matter?
How do I find my break even point?
Before we go into whether or not a break even point is a valid benchmark or goal to work towards, we should probably explain how to work out it out. There is a very straight-forward equation to help businesses work out their break even point which is expressed like this: Fixed costs / (Price – Variable costs) = Number of break even units.
To work this out the first thing you need to do is establish your fixed costs. Fixed costs are the costs your business has regardless of how many products it sells or how many customers it has. They are fixed over a period of time such as a month or a year. Include things like premises costs such as rent or a mortgage, payroll for salaried staff, utility bills and insurances and loans. It would also be prudent to include depreciation. By this we mean taking into account that office equipment you have bought will depreciate over time.
Next look at your variable costs. These can be tricky to work out, particularly as your business grows, but, essentially, we’re talking about the cost of things like materials and wages and activities like marketing, that you can specifically link to a product.
Once you have established these figures, take your total fixed cost and divide that by the price you charge for your product or service minus the cost of your variable costs. The answer to this will give you your break even amount of units to sell.
How important is it to know your break even point?
Generally speaking, businesses like to know their break even point because it can help them to work out what they need to achieve to become profitable. Many business owners would say their break even point gives them a point of focus because it makes them aware of their minimum financial and operational performance level. It gives them the confidence to model different ‘what if’ scenarios often based on how many sales they need to generate depending on whether they raised or lowered their prices.
However, I would argue that knowing your break even point is far from being the be all and end all of running a successful business. In fact, I would go as far as saying I think ‘break even’ is an outdated concept.
Having been a Chartered Management Accountant for nearly a decade and a half I often find that one of the key things that business owners regularly forget to factor into their break even analysis is their own salary. Breaking even, but not being able to pay your bills, is no victory in my book. Think about what you wanted to achieve when you set up your business and why. Did you want to earn enough to replace what you brought home in your last employed job? Perhaps you wanted more freedom and several holidays a year. I, personally, think goals like this are much more important than a break even point.
If a break even point is outdated, what financial goal or point should I aim for instead?
I’m not saying there is no place for break even analysis. It can be a useful exercise to carry out to stay on top of your numbers, but when I am working with business owners I encourage them to prioritise the type of lifestyle they want to achieve over fixating on break even data.
Business owners should think about things like how many hours they want to work, what sort of salary they want to pay themselves and what is the minimum they need to earn to live their life. Everyone works with the hope that it will provide them with a good lifestyle so to me it’s common sense that business owners should work with the lifestyle they want to achieve in mind rather than their break even point.
I would argue if you want to have fewer sleepless nights it’s also essential to aim to create a cash surplus for your business. This allows you to reinvest in the business to enable it to grow and also gives you the peace of mind that your organisation is strong enough to cope with any unforeseen emergencies.
This time last year no one was predicting how badly Coronavirus would hit the UK’s economy in 2020. The UK’s hospitality sector alone saw its sales figures drop by more than £53 billion last year, many high street names went into administration and thousands of workers lost their jobs. Anyone who managed to keep their business going through the challenges of the Coronavirus pandemic in 2020 will have seen first hand how vital a cash surplus can be.
Another piece of advice would be to be aware of your business’ outgoings and ensure you are making the most of the business tools you already have at your disposal. For example, if you are using Xero accounting software, make sure that you really get to grips with it so that you are using all its features and are able to use the software to help you with your forecasting, reporting and budgeting.
Lastly, if you are running your own business, don’t be scared of the numbers. Checking your costs and income weekly and monthly and then using that data for planning and forecasting purposes to reach your goals should be exciting and motivating. Aim for more than simply breaking even!
Originally posted 2021-01-04 15:48:37.
Professionally, Nishi is known for the high standard of tax planning he provides to his clients and his ability to communicate effectively. He has a knack for identifying what the real issues are and creating actions to deal with them. Listening skills are key to this ability and he often helps clients to prioritise their financial well-being thus leading to peace of mind and less stress all round.
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