How to conduct a break-even analysis
By Irene Chong
Conducting a break-even analysis maps out the costs that small businesses might incur and the revenue they might derive from their product.
As a business owner, you're always on the lookout for your next big idea. Your entrepreneurial self has come up with a great idea! But before you get carried away with the marketing material and launch-party planning, put your business hat on and see what you have to do to make it a financial success.
Conducting a break-even analysis can help you make decisions around what supplies you use or price to charge to ensure that your product is not running at a loss. It will help you map out the return on your investment and show the time frame for that return.
Whether you are an excel guru or prefer to put pen to paper, the key to breaking even is making sure your revenue is at least equal to your costs. Here's a step-by-step how-to guide.
1. Brainstorm the costs
Think about all the costs that go into your product. Costs can be split into a couple of broad categories.
- Fixed costs: These costs won't change regardless of how much product you make or other market conditions (e.g. rent, insurance or permanent staffing costs).
- Variable costs: These costs will change depending on either the quantity of your product or market conditions (e.g. raw materials, finance, casual staffing, sales or marketing costs). Grouping together costs that vary based on the same factor, such as costs that depend on quantity, allows you to complete the break-even analysis for each unit or batch of product. The nature of variable costs is such that you won't really know what the exact cost will be. You might want to factor in a worst-case scenario or best-case scenario so that you can more accurately factor in what might occur.
Make sure you include potential costs from all stages of the product's lifecycle, from the design phase through to production, sales and marketing, sale and after-sales service. You might even want to factor in unforeseen costs and allow a buffer for unexpected but potential costs you might incur.
2. Show me the money!
Calculate the amount of revenue you expect to earn. Think about the amount of the product you expect to sell at different points in time during the product's lifecycle. Sales might be slow at the beginning as you launch the product and develop a customer base, but might steady or grow as the product becomes more established.
Factor in different prices for the product and your sales strategy. You might launch the product at a discounted price to get it out to market quickly and then revise the price as your sales quantity increases. You might also consider different prices in different market segments (e.g. different suburbs, states or countries).
Now that you have all the costs and revenues laid out in front of you, compare. Are the results what you expected? Have another look at your analysis. Can you cut any product costs? Should you be charging more for it? Are there more efficient ways to do things? You might be happy selling this product at a loss for the first couple of months because it should break even after a year.
A break-even analysis will help you make product decisions not only now, but over the life of the product. You've put in the work to set it up, so keep updating it and use it as a tool to continually monitor your product.