What is Break-even and How to Conduct a Break-even Analysis for Startups
In the early stages of a startup, understanding your financial standing is essential, and one key financial milestone is the break-even point. The break-even point is where your business’s total revenue equals total costs, meaning there’s no profit but also no loss. In other words, it’s the stage at which you’re not losing money anymore—every sale beyond this point will contribute to profit.
Why Break-even Matters for Startups
For startups, reaching break-even is an important goal, signaling stability and helping build investor confidence. Knowing this point helps you understand the volume of sales needed to cover costs, set realistic financial targets, and price products or services effectively.
Conducting a Break-even Analysis
Identify Fixed and Variable Costs:
Start by listing fixed costs, which are expenses that don’t change with sales volume, like rent, salaries, and utilities. Then, identify variable costs, which vary directly with production or sales, such as raw materials, packaging, or commissions.
Calculate the Contribution Margin:
The contribution margin per unit is the selling price minus the variable cost per unit. For instance, if a product sells for £50 and costs £30 to produce, the contribution margin is £20.
Use the Break-even Formula:
The formula to find the break-even point in units is:
Break-even Point (units)=Total Fixed CostsContribution Margin per Unit\text{Break-even Point (units)} = \frac{\text{Total Fixed Costs}}{\text{Contribution Margin per Unit}}Break-even Point (units)=Contribution Margin per UnitTotal Fixed Costs
This calculation tells you the number of units you need to sell to cover all costs.
Example:
Suppose your startup has £5,000 in fixed costs monthly, a product price of £50, and variable costs of £30 per unit. Your contribution margin is £20, so:
Break-even Units=500020=250\text{Break-even Units} = \frac{5000}{20} = 250Break-even Units=205000=250
This means you need to sell 250 units per month to break even.
Using Break-even Analysis to Guide Decisions
Understanding your break-even point can help in pricing decisions, cost control, and sales target setting. By adjusting either prices or costs, you can make more informed decisions to achieve profitability sooner.