Understanding breakeven analysis for business success

What is breakeven analysis?

A breakeven analysis is a calculation that determines what it takes to ‘break even’. To reach your company’s breakeven point (BEP), your costs must equal your total revenue.  While this is a good starting point as there are no losses, it also means there’s no profit – so the onus is on you to increase revenue without costs.

Your BEP will take into account the total costs for selling X number of units, as well as the selling price per unit. To scale successfully, you need to be able to increase your sales volume without your costs rising at the same point. We can find a lower breakeven point by understanding gross margins, cost of goods sold, and gross profit.

Understanding gross margin and its role

To recap, the BEP is when our gross profit (the key to a job’s success) matches overhead costs. But overhead costs are different from direct costs:

• Direct costs are linked to individual jobs, such as equipment and materials
• Overhead costs are linked to company operations, such as rent, and tend not to vary.

To calculate gross profit, we take direct costs from revenue. Then we can find out our gross margin. This is a percentage, reached by dividing the gross profit by revenue. For example, if we make $500,000 in revenue and our gross profit is $175,000, then the latter as a percentage of the former is 35%.

Once we add up all the costs for jobs from one financial period, we can use the gross profit to pay overhead costs. Anything left over is known as net profit, so we need all of these BEP figures to determine if our business is truly sustainable.

Calculating required revenue: the formula

We can use gross margin calculations to forecast for future scaling. For example, if we want to maintain a 35% gross margin but want to add more costs, like an office, then we can figure out how much more revenue we need to generate.

We achieve this by dividing the extra costs by the gross margin (35%). So, if the costs are $21,000, we would divide this by 35% to see that we need to make an extra $60,000 per year. This helps businesses understand how to stay profitable, even with fluctuating direct costs.

Factoring in profit and growth

A key challenge for integrators is scaling the amount of revenue without costs of production rising at the same rate. Many integrators’ business plan will factor in growth, but without full financial visibility, they may risk a lower personal income.

Whether yours is an established or new business, you should have a ‘set-aside profit’. This involves taking any net profit and reclassifying it as an overhead. As such, we can recalculate the required revenue to include this extra net profit, giving you room for growth.

To calculate this, we would use:

(Overhead + desired profit)/gross margin = required revenue. So, we might have gross profit of $225,000, which includes overheads of $175,000+£50,000 ‘set-aside profit’. This gives us a new view of the breakeven point to factor in future growth, thereby setting revenue targets. With this revised breakeven analysis formula, we can review our pricing strategy and sales targets, as well as try to lower fixed costs.

The impact of margin slippage and overhead changes

There are multiple factors that can affect margins, which is why it’s so important to have fully visible financial modelling. For example, we can calculate the contribution margin, which deducts the cost of goods sold from the sales price.

If something changes, such as the price of raw materials, then margins could slip. This means we have to increase our revenue requirement to cover the gross margin reduction, and so our minimum breakeven sales will change.

Other factors such as market demand may change, so every small business should keep their finger on the pulse. At CEDIA, our simple Excel breakeven templates can help you forecast to account for these changes.