What is Break-Even Analysis and How to Calculate It
Digital Marketing Metrics•
August 23, 2022
- Brand Awareness •
- Business •
- Conversion Rate •
- Digital Marketing Metrics •
- Marketing •
- Strategy •
Ana Gotter• August 23, 2022
There’s nothing quite like that wonderful surging feeling of seeing sales come in. That net profit that shows you the total amount of pure revenue you’ve made can be exhilarating… but net revenue isn’t the only part of the picture you need to look at.
Gross revenue is actually the number you need to be looking at. Your gross numbers will tell you how much profit you’ve made after your expenses are accounted for.
You could make 2M in sales but be headed towards bankruptcy if you’re not careful.
That’s why it’s so essential to know what your break-even point is and how to calculate it. In order to do that, you need to know how to conduct break-even analysis calculations, and in this post, we’ll show you how.
What is Break-Even Analysis?
Break-even analysis is the practice of assessing both your profit and your expenses so that you can discover a true “break-even” point. Your break-even point tells you at what point you meet profitability.
Let’s say you’re a fiber internet provider. It costs 10k to run wires to a neighborhood, so you can’t really afford to do it for a single customer who wants the service. When you look at a break-even point, you need 225 customers to agree to sign up for one year of service in order to offer free installation and still maintain profitability with your other costs (labor, equipment, online customer portal, employee wages, etc). That’s your break-even point.
It’s crucial to understand where your break-even point is and what different factors can impact it. It gives you an understanding of true profitability and it enables you to make better business decisions ranging from marketing, product pricing, employee hiring, and more.
You can use break-even analysis to look at your entire business’s profitability, but you can also use it in specific departments. You might look at the break-even point of ROI from a marketing campaign, for example, to see how much you can spend on clicks or CPAs in order to have profitable campaigns.
How to Calculate Break-Even Analysis
Calculating your break-even point is going to look at fixed costs, sales prices, and variable costs.
Your fixed costs are any expenses that do not change, or that may change only slightly. Examples might include:
- The lease for your office
- The $100 a month you pay for accounting software
- The cost of the phone line and internet plan you pay monthly
Sales price per unit tells you how much the company charges consumers for one of the products or services that you’re running the calculation on. You may charge $100 a month for lawn service, for example, but $500 for a lawn design consultation.
Your variable cost per unit is going to look at costs that are not stable or consistent, but that are directly tied to production of a content. Examples of variable costs include:
- The labor involved in making the product (it costs more to install tile in someone’s home than to install laminate flooring, for example)
- Materials used (a dress made of cotton will be less expensive to produce than a dress made of luxury silk)
In order to calculate break-even analysis, you’re going to use the following formula:
Fixed costs / ( Sales price per unit – variable costs per unit) = Break-even point
An Example of Break-Even Analysis
So let’s say you’re a small business selling paper, Dunder Mifflin style for our Office fans out there.
Your fixed costs include employee salaries, office space, office supplies, and utilities. It costs $3,000 a month.
Your sales price per unit is $10 per ream of paper.
Your variable costs per unit are currently around $3 per ream of paper.
This will be your calculation:
3000 / (10 – 3) = 429 (rounded up)
With the current variable costs, you need to sell 429 reams of paper just to break even with your expenses.
How to Use Break-Even Analysis Calculators
If you want to keep it simple (especially if you have a large variety of products of services that you’re selling), you can consider using break-even analysis calculators.
The SBA has a useful break-even calculator that’s great for small businesses. It will ask for specific values, and even flag when there’s an issue before it even runs the calculations.
They’ll walk you through the process, making it easy if you’re nervous about getting it wrong.
3 Tips for Reducing Your Break-Even Point
Looking to reduce your break-even point so that you can increase your profitability and walk away with more gross revenue?
Every business does!
Let’s take a look at the three most straightforward ways to lower your break-even point.
1. Slash Unnecessary Fixed Costs
While most of your expenses may come from variable costs in some cases, finding ways to cut back on fixed costs can go a long way toward improving your business’s profitability.
You may realize that you’re paying $300 for email marketing software when you only need to be spending $100 after looking at the tool’s current plans and features.
Some businesses are downsizing in-person offices, prioritizing remote work. Even offering each employee a $500 stipend, they find that they’re saving significantly on month-to-month costs.
You never want to cut anything unnecessary (like quality internet or security solutions), but reduce where you can add up.
2. Reassess Your Product Pricing
Pricing can seem easy, but it’s incredibly complex.
You need to price competitively enough that people aren’t blowing you off right away because your products are too expensive. But you also need to price high enough to indicate quality and to maintain profitability.
With an established brand name or shifts in the market, you may need to increase your pricing— and customers may be on board.
It’s important to keep in mind that pricing is never going to be static. Changes in the market and in variable costs can happen very quickly (we all saw this during COVID). Even if your pricing has been working for you, reevaluate every six months to a year minimum to make sure that you’re where you need to be.
3. Invest More In Marketing & Sales
While it may seem counterintuitive to spend more money when you’re trying to cut costs, the right marketing campaigns will drive more relevant and high-quality traffic to your site. A stronger sales team will have better luck converting that traffic to sales.
Better traffic may convert faster, spend more, and retain longer. This significantly increases your profit margin overall, so even if you’re paying slightly more for ad campaigns or even a higher cost-per-click, the ROI can speak for itself.
Choose an experienced, trusted marketing agency that will work with you to get the results you want.
Here at Disruptive Advertising, we offer a variety of different marketing services that are all executed by team members who are experts in their specific niche. We can help you find the right combinations of marketing strategies that will work for you and execute them to perfection. Learn more about what makes us different here.
Knowing how to find and monitor your break-even point is a crucial part of break-even analysis and business ownership in general.
Without knowing where you need to be in order to hit and exceed the profitability line, many businesses end up spiraling towards insolvency. No one wants that, and an accurate break-even analysis can help keep you on track and spot financial concerns before they become irreparable.
Whether you choose to conduct break-even analysis manually or to use a break-even analysis calculator, make sure that someone on your team is checking the numbers regularly.
Want to learn more about how to keep your business profitable and thriving? Check out our blog for more!