You don’t have to be an accountant to know when you will Break Even
It is important that every founder does a Break Even Analysis to know the minimum sales needed to cover all expenses and determine when the business will earn a profit. In other words, this is the point where the profits on each unit sold is enough to cover the fixed costs required to start selling your product in the first place.
The first step is to research and obtain accurate data with regard to the costs of the product or service you plan to offer. Make a list, then classify each cost as fixed or variable. Not sure which is which? Here are some definitions from one of our favorite resources, Investopedia, to help you:
- Variable Cost: A variable cost is a corporate expense that changes in proportion to production output. Variable costs increase or decrease depending on a company’s production volume; they rise as production increases and fall as production decreases. Examples of variable costs include the costs of raw materials and packaging. Click here to learn more.
- Fixed Cost: A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced or sold. Fixed costs are expenses that have to be paid by a company, independent of any specific business activities. Examples include insurance, rent and wages. Click here to learn more.
Next, you’ll need to divide each variable cost by the number of units you can produce with that expense to get the per-unit variable cost. For example, if you buy 100 pounds of flour for $100, and it takes one pound of flour for every cake you sell, then your per-unit flour cost will be $1. Add up all your per-unit variable costs to get the total per-unit variable cost.
Once you have a good understanding of your costs, you can calculate your break even point – that is, the number of units you need to sell in order to cover your costs and start earning a profit.
First subtract your per-unit variable costs from the per-unit price. This is your per-unit profit margin. Next, take total fixed costs and divide by the per unit profit margin you just calculated.
The result will tell you how many units you will need to sell to cover all expenses. To be profitable you will need to sell above that number.
Magdalena C Carbonell is the Investment Analyst for ATO Ventures, an early stage venture capital fund focused on technology companies in Health, Fitness & Wellness and Digital Media & Entertainment based in Puerto Rico. ATO Ventures mainly backs pre-launch startups located in the USA and LATAM using a risk-mitigating, Market Validation Testing strategy. To find out more about investing with ATO Ventures, message Magdalena on LinkedIn or email firstname.lastname@example.org.