One of the most important parts of a business plan is the financial plan. As a business owner, you need to know the point at which your total cost and your revenue are the same or equal. Also, you want to know your margins every time you sell a product. How many units do you need to sell to cover all your costs. The break-even point calculation will show where you will start to see the return on your investment.
The importance of the break-even analysis
- Pricing. Once you find your break-even point, you will have a guideline to help you establish a product price and measure your profitability.
- Missing Expenses. After completing your break-even analysis, you will have all your expenses and financial liabilities, and this will limit any possible surprise of a missed expense.
- Revenue Targets. The analysis will tell you how many units or how much you need to sell, allowing you to set and follow your revenue goals.
- Request Business Funds. Investors usually request a break-even analysis to see if your business plan is viable and provide funds to the business.
How to calculate the break-even?
You can calculate your break-even by dividing your Fixed Costs by Unit Contribution.
Let’s suppose you are running a Craft Beer business and your fixed costs are $12,500 a month, you sell your beers at an average cost of $5 per bottle and your variable costs are $2.5. So your unit break-even will be $12,500 / ($5 – $2.5) = 5,000. In other words, you need to sell 5 thousand bottles to get a break-even, anything above is profit. This is equivalent to $25,000 in a month.
Calculating Margins
Another important financial term to know is the margin. A margin is the difference between the selling price and the costs of goods or the costs associated with the product you are selling.
Margin = Selling Price – Cost to Produce.
%Margin = (Selling Price – Cost) / Selling Price
Following the Craft Beer Brewery, let’s suppose your selling price at the brewery taproom is $5 and the cost to produce a bottle of beer is $3, so your margin will be equal to $2 or 40% per bottle sold.
Now let’s suppose the brewery has the following sales channel: Brewery – Distributor – Retailer. In this case, each piece of the cake will need to get a margin. How can we calculate this? To keep the exercise simple, let’s suppose what the margin for each channel is. We already calculated the brewery’s margin, the distributor will make a 20% margin, and the retailer will be 30%. How can we calculate the selling price of each sales channel?
Example Margin Table for the Brewery Sales Channel
| Brewery | Distributor | Retailer | |
| % Margin | 40% | 20% | 30% |
| Selling Price | $5 | $6.25 | $8.92 |
Distributor Selling Price = Brewery Selling Price / (1 – % Distributor Margin)
Retailer Selling Price = Distributor Selling Price / ( 1 – % Retailer Margin)
This simple and basic financial math is vital when starting or running a business. Nowadays, you have a vast variety of software that can help you with your accounting and finance, I hope this information will provide you with some help.
