By Terry Corbell
The Biz Coach
Accounting / Finance – Why and How to Determine Your Break-Even Point
Best practices in management mean having the right information to alleviate uncertainty in business. For that you need the right tools. One important tool – know your break-even point (BEP).
A BEP analysis should be an integral part of your financial planning. If it isn’t, you can count on suffering from unnecessary stress – emotionally and financially. You need to be able to make the right decisions because positive cash flow is paramount to facilitate success.
Generally, there are multiple benefits to knowing your BEP, for example:
- You can track when or if you’ll break even.
- You’ll be in a better position to evaluate whether your new products or services are good ideas.
- Whether to expand in other ways.
- Businesspeople who perform such analysis are often more profitable.
- In a loan scenario, the bank will want to know your BEP. Plus, you’ll know how much you’ll need to sell to successfully pay off the loan and to make a profit.
Success can be dangerous as it sometimes leads to complacency in financial management. If your business is on a roll – your profits are strong and your cash flow is positive – you’re probably not worried about your financial position.
But one thing is clear in business – you can expect negative surprises. You should be prepared for any contingency. And there are many.
To name a few: You could lose your best talent, your products can reach the end of their life cycles, or you can be hit by an earthquake or hurricane.
Sure, it helps to stay up-to-date on your checking account balance, general ledger, sales receipts and your monthly profit and loss statement. But these are insufficient – if you’re to accurately ascertain how and when to pay the bills and to meet your payroll, especially in this uncertain economy.
Time is a valuable commodity in business. Even in good economic times, most entrepreneurs are too busy putting out fires and reacting to problems.
If you understand where your BEP is, you’ll know instantly whether you can cover your obligations and know how far ahead or behind you are in terms of cash flow. The longer you wait to develop such financial information is to invite disaster. So, it’s best to be proactive.
In essence, the BEP is where your revenue equals the cost of sales plus expenses.
It’s a mistake to determine just your cost of goods or services but failing to consider your fixed costs or operating expenses, which are also called overhead.
A good friend, Neil Delisanti – the esteemed former Small Business Development Center advisor in Washington state, and who taught at the University of Puget Sound and The Evergreen State College – helped thousands of people. He also advocated a break-even analysis.
He provided this basic BEP formula: BEP = Fixed Costs divided by Gross Profit as a Percentage.
For example, if your fixed costs average $2,000 per month and your gross profit is 40 percent, your cost of goods is 60 percent.
How this BEP is determined: $5,000 = $2,000 divided by .4.
This formula indicates you will have to achieve $5,000 in sales to cover your cost of goods and fixed expenses.
If you attain your BEP in each reporting period you’ll be OK. After you achieve the BEP, the balance is yours.
Remember, this proactive tool is helpful to avoid or get out of difficulties while you still have time to do the necessary footwork. So manage the books and be ready for change – any change — especially negative change.
From the Coach’s Corner, here are related resource links:
- Primer for Best Practices in Preparing Financial Statements
- Step-by-Step Solutions for a Company Turnaround
- 8 Simple Strategies to Give You Pricing Power
Change is inevitable, except from a vending machine.
Author Terry Corbell has written innumerable online business-enhancement articles, and is a business-performance consultant and profit professional. Click here to see his management services. For a complimentary chat about your business situation or to schedule him as a speaker, consultant or author, please contact Terry.