To prepare your break-even analysis for your potential startup business you have to make an educated guess as to the number of units you can sell, the expected sales price per unit, fixed costs and variable costs. This educated guess is made on the basis of research.
Once you’ve estimated the four numbers above, it’s easy to calculate your break-even point by using the following formula:
Break-even Point = Fixed Costs / (Unit Selling Price - Variable Costs)
Let’s see how that works in an example where we estimate we can sell 1,200 widgets per month at $10 each, resulting in sales revenue of $12,000. We estimate that our fixed costs for rent, utilities, and so on are $5,000 per month. We also estimate that it will cost us $5 per widget to buy raw materials and prepare the widgets for sale (our variable cost).
Plugging our numbers (except the number of widgets we expect to sell) into the formula, we get the following:
Break-Even Point = $5,000/ ($10 - $5)
or, Break-Even Point = $5,000/$5
or, Break-Even Point = 1,000 widgets per month
At the Break-Even Point, then, we would sell 1,000 widgets at $10, for sales revenues of $10,000. Our costs would be $5,000 fixed costs + $5 x 1,000 widgets, or $10,000. If we sell more than 1,000 units per month we make a profit. If we sell fewer than 1,000 widgets per month, we lose money.
Based on our break-even analysis, we calculate that if we sell the number of widgets projected, 1,200, we would make a profit of $1,000 per month, as follows, using the numbers we already know:
Profit = Sales Revenues – Fixed Costs – (Variable Costs x Units Sold)
or, Profit = 1,200 units x $10 - $5,000 – ($5 x 1,200)
or, Profit = $12,000 - $5,000 – $6,000
or, Profit = $1,000 per month
Are you satisfied with $1,000 profit per month? If not, you must have a plan to increase sales or lower costs. Maybe you can start by selling 1,200 widgets per month, knowing you will earn $1,000 per month and then have a plan to expand your product line. Many such issues can be addressed once you have determined your break-even point and your expected profit given your expected sales.