Let’s pretend we’re a donut shop. We started the business because we wanted to make money (and really like making donuts.) No matter the type of business chosen, we ask the same question as we go through setting up and starting: “When do I get to the point where I start bringing in more money than I spend”? We can answer this with the Breakeven Analysis.
Start your Breakeven Analysis by asking yourself these questions
- How much will we charge for each item or each hour of work?
- We plan to sell each donut for $0.50 each.
- What are our costs for each unit produced or each hour worked? (These are variable costs.)
- Each donut costs us $0.25 to make.
- What are your costs that are non-directly related to producing your work, i.e. office rent and utilities? (These are fixed costs.)
- Our store rent, equipment rental and utilities come to $2,000 a month.
- How many items will we produce? If you’re a service-based business (such as accounting), how many hours will you offer? (The key is that you can actually SELL this amount of product or hours. But don’t forget to include time needed for marketing, legal, vacations and (of course) social media. People often think they can bill out 40 hours a week when they can’t.)
- We have to do the formula to find out the answer for our business.
- How much do we hope to profit?
- $2,000 each month.
A few assumptions to be kept in mind during the Breakeven Analysis
First, your costs are either fixed or variable with no change from either category over the course of the level of activity. Second, the only thing affecting total costs are changes in activity. Any changes to these assumptions would invalidate this analysis.
Determine profit by using the Breakdown Analysis formula
We use the answers to the above questions and the following formula to determine how many donuts we have to make in order to reach our goal profit:
- (Sales price x number of items to be sold) – (variable costs x number of items to be sold) – fixed costs = PROFIT
- ($0.50 x number of items to be sold) – ($0.25 x number of items to be sold) – $2,000 = $2,000
- ($0.25 x number of items to be sold) = $4,000
- Number of items to be sold = 16,000
Time to start asking more questions
- Can we sell 16,000 doughnuts a month?
- Can we up the price to $1.00 a piece, which would cut the number that need to be sold in half?
- Cutting the costs, either variable or fixed, can also reduce the number to be sold.
This is a great exercise to do when you are looking at expanding or starting your business, to determine if you can make the kind of money that you need to finance your lifestyle. Talk to a good accountant who can walk you through this exercise with information more relevant to the type of business you have or want to start.
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