Nine out of ten businesses incur expenditure simply by opening their doors to customers. Common expenses that may be incurred include rent, staff salaries, telephone line rental and insurance.
Do you know the level of sales that you need to generate on a daily, weekly, or even a monthly basis in order to meet your fixed expenditure and hence break-even?
The break-even point of your business is where the income generated is equal to the expenses incurred in operating the business. As such, every dollar of sales above the break-even point will contribute to net profits.
To calculate the break even point you must determine the total expenses ie, fixed costs plus variable costs then determine the number of sales you need to generate to cover the costs of operating the business.
A Fixed Cost is an expense which remains constant regardless of the amount of sales generated by the business. An example of a fixed cost is rent.
A Variable Cost is an expense which increases as sales levels increase, and vice versa. An example of a variable cost is sales commissions.
The basic formula for calculating the break-even point is:
Gross Margin Percentage
For example, if the fixed costs of a business are $25,000 and the gross margin percentage is 40%, the sales amount required to break-even is $62,500.
This is demonstrated further as follows:
Sales Revenue $62,500
Less: Variable Costs* (37,500)
Less: Fixed Costs (25,000)
Net Profit nil
* Variable Costs are calculated as sales revenue multiplied by the variable cost percentage (100% – gross margin percentage).