Break-even analysis: How much are you Really Making?
By: CPA Kyle Brown
As an entrepreneur and a CPA, I see this all of the time in my community. A majority of within the field is only worried about the product/service and has disdain for the accounting and finance side of entrepreneurship.
A break-even analysis is both simple and essential in the business world and involves three main components - revenue, fixed costs, & variable costs. When revenue equals fixed costs plus variable costs you have achieved a break-even point.
Your fixed costs never change - imagine rent, salaries/admin labor, insurance, etc. These expenses are the same every month whether you sell 5 floral bouquets or 5,000 floral bouquets.
Your variable costs represent costs associated with the floral bouquets you sell. Think about the flowers, the wrapping material, direct labor (cost of the labor making that actual bouquet).
When you subtract the variable costs of each bouquet from the sales price of each bouquet you have your contribution margin - this is a very important number to know in your break-even analysis.
Let's assume Rent and Insurance are your only two fixed expenses and they amount to $10,000 combined.
You sell your floral bouquets for $50 and each one costs $20 to make. The
$20 consists of $12 of flowers, $1 for the decorative wrap, and Employee A gets paid $14 per hour and is able to make 2 bouquets per hour - therefore costing $7 in labor per bouquet.
Your contribution margin is $50 sale price minus $20 variable cost - $30 contribution margin per bouquet.
Now that you have your contribution margin that math is simple - Take your fixed costs of $10,000 per month and divide it by your contribution margin of $30 - you need to sell 334 bouquets to break even for the month.
If that number is out of reach, whether it be because of storage space, production abilities, or product availability and you believe the most you can produce is 250 bouquets per month you back the math in to find where you need to price your bouquets. $10,000 in fixed costs per month divided by 250 bouquets produced yields a contribution requirement of $40 per bouquet.
Your options here are:
Raise the price of your bouquet to $60 ($60 - $20 Variable costs = $40 contribution margin)
Improve the efficiency of your operations - source cheaper product, invest in employee training to become more efficient, etc
If a price increase is unavoidable - hopefully there is not an existing customer base with expectations set. If you are in the planning phases and have not released a product yet, then a price increase is not that difficult.
If you have a customer base already, you will really need to find a way to add value in order to avoid a poor perception in the customer's eye. Most likely you will raise the variable cost of your product by doing this - but can always rerun your break-even analysis to make sure you are in the money!