One of the key challenges facing any new business lies in determining the point at which you will break even, namely, where you will earn sufficient revenue to cover your costs before moving on to generate a profit.
Break-even volume is the quantity of sales required to meet your fixed costs, or ‘overheads’, such as insurance, rent and utilities plus the interest cost of any financing.
A good starting point to determine your venture’s break-even volume is to determine your fixed costs for a full business year. Next, divide each cost by 12 to give you a monthly figure. The table below provides a simple example of monthly fixed costs:
Rent $600
Phone, power and water 200
Internet 100
Stationery and supplies 50
Advertising 50
Total monthly fixed costs $1,000
In this scenario the business needs to achieve monthly gross profit (revenue less the cost of goods sold) of at least $1,000 to break even. If the same business has a gross profit margin of 20% (meaning a mark-up of 20% is added to the goods sold), the monthly sales volume must reach 5,000 each month to cover fixed costs ($1,000 divided by 20%). If less than 5,000 units are sold, gross profit will be insufficient to cover fixed costs and the business will generate a loss.
If you believe your business is unlikely to achieve break-even sales volume, it may be possible to lower the break-even point. One way to do this is by lowering the cost of goods sold. This may be achieved by changing to a less expensive supplier, however you need to be sure product quality and reliability of delivery times remain acceptable.
Alternatively, you may be able to trim your fixed expenses. Again, you need to be certain quality isn’t compromised when costs are cut.
A further option in meeting break-even point is to raise the selling price of your product. This should only be considered if you are quite certain that sales volumes won’t suffer, which could potentially leave you no further ahead.
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