Determining the Break-Event Point
Knowing and understanding the break-even point for your company is a necessity. It helps with answering questions like:
· How many customers do you need in order to earn a profit?
· How many customers do you need have in order to pay yourself a fair salary from your company?
Break-even is the point at which a business earns no profit or loss. It is the point where revenues exactly covers expenses. To explain the process for determining the break-even point, I am going to use as an example the costs for small barber shop that operates as a sole proprietorship.
Start by assigning the company’s operating expenses as either fixed, variable, or semi-variable. A fixed expense is an expense that does not change when sales increase or decrease. Variable expenses are those expenses that decrease when sales decrease and increase when sales increase. A semi-variable expense is an expense that is part variable and part fixed. For example, a commissioned employee that has a base salary would be a semi-variable expense. (Simply place the base salary under fixed expenses and the commission fees under variable expenses.).
Next add the fixed expenses and variable expenses. In our example, the barber shop has variable expenses per customer of $2.00. A basic wash and haircut is $15.00. The fixed expenses per week are $400.
Rent and utilities $150
Labor including payroll taxes $250
Then calculate the contribution margin. Think of contribution margin as the amount left to cover fixed expenses. It is calculated as: contribution margin=revenue-variable expenses. In this case, the revenue is $15.00 per customer. Thus, the contribution margin is $15.00 per customer less $2.00 per customer equals $13.00 per customer
Calculate the break-even point. The formula for breakeven is fixed expenses divided by contribution margin. In this case, $400 per week/$13 per customer= 30.76923 or 31, which is $461.53845 or $462 in revenue ($15*30.76923=$461.53845 or $462) in sales per week.
Sales (31 customers paying $15 for services) $462
Variable Expenses (31 customers at $2.00 per customer) $62
Contribution Margin $400
Fixed Expenses -$400
Net Income 0
So what does this mean? It means that the barber shop needs to serve more than 31 customers a week to earn a profit.
To determine how much of a salary the owner of our fictional barber shop could draw. Let’s assume, the owner wants to pay him/herself about $500 a week. To calculate the break-even for the draw requires adding the $500 a week to the fixed expenses so that fixed expenses amount to $900. So the break-even point is now 69.230769 or 70 ($900/$13) customers a week or $1038 ($15*69.230769=$1038.4615) in sales per week.
Note that the above scenario excluded the differences among the hair care services and other barber shop services. Calculating the break-even point for your business is not always this easy, which is why I have an easy-to-use break-even spreadsheet. To receive a copy of this spreadsheet, send me an e-mail at email@example.com.