Break Even Analysis Definition
The break even analysis definition is the studying the path to the point where a company is neither losing money nor making a profit. It is very important to the survival of any start-up business. You can perform it for either products or the business as a whole. Reference the break even expenses as either pro or post-forma – that is before or after the company has been formed.
Break Even Analysis Explanation
The break even analysis serves to provide the company with a very important piece of information: “How much revenue does the firm need to make in order to break even?”
This break even analysis is quite easy to do. The only critical piece of information that you will need to attain is a breakdown of the your firm’s expenses into Fixed Expenses and Variable Expenses.
Once you have a breakdown of fixed costs and variable costs, input these costs into the template. You will also be able to conduct various “What if” scenario analyses to see how the breakeven revenue will change.
Once you are able to arrive at the break even analysis, you can show the Owner(s)/Management this metric and make it part of their sales planning. Another idea might be to incorporate this metric into the Flash Report review meeting. This way your staff can know on a weekly basis if they are on track to at least breaking even.
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Break Even Formula
Use the following break even formula:
Break Even Point: Total Revenue = Total Costs
Prepare a Break Even Analysis
Let’s look at how to prepare a break even analysis.
Accumulate Expense Information
In order to successfully prepare a break even analysis, you need to gather and/or create the following financial information: Current Monthly Fixed Expenses (Dollar Basis), Current Monthly Variable Costs (as a Percentage of Revenue) and any “What if” scenario changes that you would like to consider. Note: This is optional depending on whether or not you would like to conduct a sensitivity analysis.
Depending on the robustness of your financial system, you may or may not have some of the above inputs. As such, it may be necessary to first create them prior to working on the break even analysis.
Once the initial break even analysis has been done, it will just be a question of maintaining it by inputting the most recent financial information. This maintenance can be done on either a monthly or quarterly basis. The CFO/controller should set it up. Another consideration would be to “outsource” the task to a consultant. Once you get the expense info, you will need to separate the list into a Fixed Expense portion and a Variable Expense portion.
Also, as part of your break even analysis, you may want to discuss any “What if” scenarios with the Owner(s)/Management. They will be able to provide any direction you need with regards to changes in expenses going forward.
Input Expense Information/Scenario Analysis
Once the initial break even analysis is done, you can also input alternative scenarios under the “$ Change” OR “% Change” columns. Do not input data into both columns as the program will sum up both together.
Once you have gathered and/or organized all the expenses into either the Fixed or Variable group, it will now be time to enter the appropriate data into the template.
List each type of fixed expense under the “General and Admin/ Fixed Expenses” header. You can usually get this information off of your income statement.
NOTE: Express fixed expenses in dollars. Input the dollar value of each fixed expense item under the “Base” heading.
List each type of variable expenses will be entered under the “Variable Costs” header. You can usually get this information off of your income statement.
NOTE: Variable expenses are expressed in terms of percentage of revenue. Input each variable expense item as a percentage of total revenue under the “Base” heading.
Once the initial breakeven analysis is done, you can also input alternative scenarios under the “$ Change” OR “% Change” columns. Do not input data into both columns as the program will sum up both together.
Input your changes in the areas highlighted EITHER in yellow or aquamarine. DO NOT enter changes in both columns as the program will sum up both columns.
Input your changes in the yellow highlighted area only.
The program will calculate the contribution margin and the sales necessary to achieve breakeven status. Please note that this break even analysis assumes a single/composite product line. You may want to use a more sophisticated approach to ascertain the break even point for a mixed product group.
Once the break even analysis has been done, it will be very easy to update it. Line items on the income statement usually don’t change. However, it may be worth double-checking to make sure that no additional expense line items have been made. Having done so, it will simply be a matter of updating the figures for the expense line items.
Once you have set up the initial break even analysis template, it will just be a question of maintaining it by inputing the most recent financial information. You can do this maintenance either on a monthly or quarterly basis.
Break Even Analysis Example
For example, Sly is considering starting a new business. Sly, an experienced business person and professional in his field of expertise, knows that proper planning is essential to consistent company profits. He wants to see that his company can survive before he creates it.
Break Even Calculator
Sly initially scours the internet for the keyword “break even calculator”. Unsatisfied with the result, Sly really wants to get his hands dirty. He decides to perform his own break even calculation on paper before he creates financial models.
First, Sly estimates total revenue. He thinks about all of the products and services he would provide which create income. Now that he knows these he thinks about what he could sell them for. He does a little competitive research to find the standard market price for his products. Sly settles on this as a good point to begin his assumptions. He considers his products in reference to how many he can sell a year and decides he will be calculating break even points for each year.
Then, Sly estimates total cost. He thinks about the resources needed to conduct business. Add overhead, cost of goods sold, salaries, and other factors. Once again Sly assumes the cost of these based on what he sees as the average cost of these resources in the market. He adds these together in regard to each year.
Sly now has his total revenue and total cost per year. Though these are estimations, he is satisfied with this acceptable starting point. He moves on to subtract these total costs from his total revenues. Sly finds that he actually stands to loose, not gain, money from the business idea he is currently studying. Sly considers scraping his idea but decides to keep his notes and look deeper into the model. Though he has not found the results he is looking for, he is pleased to have performed a proforma break even analysis. In his current situation it is much worse than performing a post-forma break even analysis.
Break Even Analysis Template
A break even analysis template can be found at: S.C.O.R.E. Template Gallery.
If you want to find out more about how you could utilize your unit economics to add more value, then click here to download the Know Your Economics Worksheet.
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