Break Even

The Importance of Break-Even!

Break-even is not a cunning way of destroying your competitors business operation, or of getting your own back for their successful promotion last Tuesday. No, instead your break-even point is the moment when your incomings match your outgoings and your business is neither making, nor; perhaps more importantly lossing, money.

So many new business fail to understand the importance of the break even point, or come to it too late once their time, money and hard work have already been invested. Working out this equation early on helps not only to analyse the viability of a business but also helps to develop budgets, business plans and reduce uneccessary expenditure. In fact, in my opinion its one of the most important numbers you should have at hand throughout your business building life.

Working out your break-even point can be very tricky if your developing a new business as you may not have any figures to go on, if you're taking over an existing business, or indeed already running one, its a bit easier as you have some numbers to work with. If you are unsure about costs try using industry standards as a guide - I would recommend creating Optomistic, Realistic and Pessimistic figures and basing any business plan on the Pessimistic numbers. Industry Standard figures can be downloaded from our resources page.

Firstly you need to work out all your outgoings, often called your fixed costs. This should include staffing, utility bills, rent, rates, waste disposal, basically everything that you are going to spend money on. Then you need to know the gross profit you are making on your incomings - this is often expressed as your revenue less your direct costs. (Your direct costs would be purchases of the items you sell that generate your revenue - food for a restaurant, beer for a pub, etc.) Whats left from your revenue after your direct costs is often described as your contribution.

Don't panic yet! It's not as complicated as it sounds - although you will find many different names for the same equation! In my description the equation for the formula above would look like this:

Revenue - Direct Costs = Contribution (Gross Profit)
Contribution (Gross Profit) - Fixed Costs = Net Profit

Ok, so lets use an example. Imagine you run a restaurant and you only sell one dish (its a very good dish, very popular and the service is amazing.) This dish costs you £4 to make (this is the direct cost) and you sell it for £10.00 (your revenue). As you can see your contribution is therefore £6 for each dish you sell. The fixed costs of your restaurant are £600 (This includes all your bills remember). Therefore you need to sell 100 dishes to hit break-even (600/6=100). With this information you can work out how much money you need to make to hit break-even. Simply multiply the number of dishes you need to sell (100) by the selling price of each dish (£10.00). Your restaurant needs to make £1000.00 to hit its break-even point.

Of course its very unlikely that you'll only be selling one dish or item and each item probably won't provide the same contribution. Once you understand the equation though you should be able to estimate the average contribution of all your items. To make it really easy you can download the BARventure Break-even spreadsheet which will work it all out for you. Simply add in your GP% and your total fixed costs and it will give you your sales revenue (inc. VAT) that you have to hit to make breakeven.

Simple! Once you know your break-even you can use this as your budget for the first year. This is very important if you are borrowing money and helps you evaluate the viability of your business proposition. You should also revue this number frequently - adjust your fixed costs if the rent goes up, or if you have to take on more staff or increase their wages - see how this affects the amount of revenue you need to make. The more you play with the numbers - the easier it become to understand them.

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