A break-even point (BEP) is a financial metric that indicates when a business’s revenues and costs are in equilibrium. A break-even point is essential for any startup’s financial projection because it gives entrepreneurs an understanding of when their business will become profitable. Knowing when a business will reach its break-even point will enable entrepreneurs to make informed decisions about the operations of their business.
Calculating the break-even point is a simple and straightforward process that requires understanding of the variables that affect a business’s profitability. In this article, we will explore how to calculate the break-even point in a startup’s financial projection and understand its importance to a startup’s financial health.
This article is broken down into the following six sections:
What is the Break-Even Point?
What Variables are Involved in the Break-Even Point Calculation?
How to Calculate the Break-Even Point?
What is the Break-Even Analysis?
How to Use the Break-Even Point?
- What is the Break-Even Point?
- What Variables are Involved in the Break-Even Point Calculation?
- How to Calculate the Break-Even Point?
- What is a Break-Even Analysis?
- How to Use the Break-Even Point?
Calculating Cost Structures
In order to effectively calculate the break-even point of a startup financial projection, it is important to accurately assess the cost structures associated with the venture. This includes fixed and variable costs that the business anticipates rolling up into their operations.
Fixed costs are typically considered non-discretionary and occur regardless of production levels. These costs stay the same from month to month and typically include rent payments, loan payments, office supplies, employee salaries, marketing and IT expenses, and insurance.
These costs won’t necessarily decrease or increase depending on production, and in order to understand the financial position of the business, these should be accurately projected upfront.
Variable costs are those costs that are contingent upon production levels. This includes materials costs in manufacturing businesses, labor needed for product fulfillment, distribution costs, and commission payments to sales staff.
Unlike fixed costs, variable costs will increase or decrease depending on production. A greater understanding of variable costs allows you to make more precise projections of the break-even point.
Calculating Revenue Structures
When creating a financial projection for a startup, it's essential to understand the sources of income and revenue streams and properly calculate the break-even point. In order to accurately forecast the break even point, you must calculate the revenue structures.
Sources of Revenue
First, identify the various sources of revenue available to the startup. These can range from the sale of products or services, to investments or grants from venture capitalists, to sponsorship or donations. Calculate the value of each source, and then construct the revenue stream accordingly.
Once all of the various sources of revenue have been identified and their respective values calculated, you should then project the eventual amount of earned income. This will enable you to determine the break-even point by subtracting the total costs and expenses from the total earned income. To get a more accurate estimate, it’s best to factor in the expected rate of expansion and growth, as this will help to offset the costs.
Be sure to adjust the projected earnings based on any potential risks or variables that could influence the expected income. For example, if you anticipate that your product or service may be subject to poor sales, price fluctuations, or competition, then factor this into your adjusted projections.
Understanding Revenue & Cost Asymmetry
When calculating your break-even point, it is important to understand the potential for uneven costs and revenues in your startup financial projection. Uneven costs and revenues refers to varying cost and revenue amounts associated with sale or service of a product or service. This asymmetry can be a major asset in achieving break-even if leveraged properly.
Potentially Uneven Costs and Revenues
An example of uneven costs and revenues is visible in a service based business. For this kind of venture, customers may desire additional services which can increase fees associated with the services provided. This can be a great opportunity to increase revenue without having to raise costs of production significantly.
Revenues may also be uneven based on the products and services offered. For example, some products such as digital goods have lower production costs than physical products requiring manufacturing. The lower cost of production can then mean higher margins per sale for the business.
Leveraging Uneven Earnings
When calculating your break-even point, it is important to consider the potential for higher revenues generated by higher end offerings. If a service allows for additional fees, understanding how those fees can increase revenues without much addition in production cost can help you understand your break-even point better.
Similarly, when dealing with products, levering lower production costs associated with digital goods may allow for more wiggle room with pricing. This can help you optimize pricing to increase profit margins for higher end items and help you reach your break-even point faster.
Setting Appropriate Margins
When calculating a break-even point for a startup financial projection, setting appropriate margins is an essential part of the process. Margins help to identify a point at which the business begins to make a profit, as well as assess the overall viability of the venture.
Differentiating Profit and Loss
It is important to first understand that there is a distinct difference between profit and loss. Profit occurs when the total revenue brought in through sales and services exceeds the total costs incurred by the business. Conversely, a loss will occur when the costs are more than the revenue.
In order to set appropriate margins, you must calculate the Gross Margin (GM), which is the net sales minus the cost of goods sold. This gives you the total profit per item sold. You can then calculate the Gross Profit Margin (GPM) which is the Gross Margin divided by the net sales.
Ensuring Viability of the Business
Once you understand your Gross Profit Margin, you can use that number to help calculate the break-even point. To do this, you must calculate the overall fixed costs of the business, such as rent, insurance, utilities, and wages. You must also factor in any variable costs such as materials and supplies.
Once the total fixed and variable costs are added together this will give you the break-even point. This is the point at which the business begins to turn a profit, and will help to ensure the viability of the business moving forward.
Utilizing Break-Even Software
Break-even software can provide an automated efficiency to any startup’s financial projection. By quickly and accurately calculating the break-even point of a startup, a founder will have an easier time understanding how much money they need to make in order to cover the cost of their venture. Many of these break-even software solutions have graphical interfaces, allowing for a greater accessibility of the data and making it easier to share information among relevant parties.
Break-even software can usually be acquired for a reasonable price. It is important to familiarize yourself with the software’s features and capabilities before making a purchasing decision. In addition, some software may require additional informational input to accurately calculate the break-even point.
Certain break-even software may provide more in-depth financial analysis than others, giving founders an even further look into the financial health of their venture. This type of analysis can be important in making the adjustments required to turn a profit and make a successful go of your startup.
Understanding a break-even point is an important step in the business planning process. Calculating a break-even point allows entrepreneurs to determine the financial viability of a business concept based on fixed costs, variable costs, and revenue. By utilizing break-even point calculations, entrepreneurs can better understand their operating expenses and the total cost of running the business.
Summary of Break-Even Point
The break-even point is the level at which total costs and total revenue are equal, resulting in neither a profit or a loss. In a financial projection, it is the point at which total revenue equals total expenses, including both fixed costs and variable costs. Break-even point calculations take into account the unit sales needed for a business to cover all costs.
Benefits of Utilizing Break-Even Point Calculations
By calculating the break-even point, entrepreneurs can better understand their operating costs and the total cost of running the business. Through this information, entrepreneurs can further refine their financial projection models to ensure profitability. Utilizing break-even point calculations also provides entrepreneurs with financial insights which help them to make informed business decisions and plan for the future.
Calculating the break-even point for a startup is an important factor to consider when planning for success. By understanding the break-even point, entrepreneurs can gain a better understanding of their operating costs, total revenue, and potential profitability. Utilizing break-even point calculations can provide entrepreneurs with the financial insights needed to make informed decisions and plan for future success.