Breakeven Analysis : Profit Planning
In the excitement of setting up a new business, one of the key forecasts of profitablity in the planning process is often overlooked.
Breakeven analysis is a really interesting tool in planning for profit, because it allows business owners to calculate how many sales they need to achieve in order to cover all their costs. It is the point at which the revenue of the business equals the costs of the business.
Breakeven analysis can be used to set pricing in order to achieve a certain level of profitability. Or it can be used to play around with “what if” scenarios – eg what will our profitability be if we make this many sales or if we change our prices or if we move to new premises or take on a new office administrator.
In order to calculate the breakeven point, a business needs to know:
- Their fixed costs. Fixed costs are those that are incurred by a business regardless of the number of sales that are taking place. Some examples of fixed costs might be office rent, wages, software rentals, staff amenities, telephone, printing.
- The variable costs. These are the costs that are directly incurred by sales. In accounting terms, they are the “Cost of Sales”. Examples of variable costs depend on the business – in a retail store, the cost to the business of buying the stock in order to sell it on is the variable cost. In a service business, the cost of the labour to provide the service to the client is the variable cost.
Once these costs are known, the business is able to calculate the gross profit per sale – For example, a consulting business might sell services at $140 per hour (ex GST) and employ staff at $40 per hour plus super@ 9.5% and plus workcover @ 1.5%. Their gross profit per sale would be the hourly revenue of $140 less the variable costs ($40+$3.80+.60) =$95.60
Their total fixed costs might be $1500 per day. In order to cover their costs, they must sell $1500/$95.60 (fixed costs divided by the gross profit per hour) = 15.69 hours of consulting per day in order to break even.
Or another example, a retail business might sell coffee and cake. Their typical sale might be $8, with variable costs (the cost of the packaging, the coffee beans and the muffin) adding to $2.50. The gross profit per sale would be $5.50. Assume their fixed costs are $800 per day. Fixed costs of $800 divided by the gross profit per sale of $5.50 = 146 sales per day in order to break even.
In order to calculate the number of sales required to obtain a particular level of profit, the profit is simply added to the total fixed costs.
So in the case of the retail business, if they wanted a profit of $500 a day, then the calculation becomes fixed costs plus planned profit ($800 plus $500 = $1300) divided by the gross profit per sale ($5.50) = 236 sales per day.
Another way to use this analysis is to look at the effect of changing prices…in the case of the café, what if they put the price of their coffee up by .50 cents and they want to achieve the same profit? ($800 plus $500 = $1300) divided by the gross profit per sale ($6.00) = 217 sales per day to achieve the goal, or 19 sales less per day.
We’ve prepared a spreadsheet that allows you to easily determine breakeven point and play around with “what if” scenarios for achieving varying profit levels, and the consequence on the number of sales and the prices charged. You can download it ‘here‘.