Break Even Analysis...How Important is this to Small Business Owners?

Break Even Analysis Definition-
Break even analysis, defined as the studying of the path to the point where a company is neither losing money nor making a profit, is very important to the survival of any start-up business. It can be performed for either products or the business as a whole. The break even calculation can be in reference to pro or post-forma, that is before or after the company has been formed.

Break Even Analysis Explanation-
The break even analysis serves to provide your company with a very important piece of information: "How much revenue does my company need to make in order to break even."

This break even analysis is quite easy to do. The only critical piece of information that you will need to have is a breakdown of the your firm's expenses into Fixed Expenses and Variable Expenses.

Once you have a breakdown of fixed costs and variable costs, input these costs into a template. You will also be able to conduct various "What if" scenario analyses to see how the break-even revenue will change.

Once you are able to arrive at the break even analysis you can show the Owner(s)/Management this metric and make it part of their sales planning. Another idea might be to incorporate this metric into your review meetings. This way your staff can know on a weekly basis if they are on track to at least breaking even.

Break Even Formula-
Break Even Point: Total Revenue = Total Costs

Break Even Analysis: Process-
Accumulate Expense Information

In order to successfully do the break even analysis, the following financial information will need to be gathered and/or created: Current Monthly Fixed Expenses (Dollar Basis), Current Monthly Variable Costs (as a Percentage of Revenue) and any "What if" scenario changes that you would like to consider. Note: This is optional depending on whether or not you would like to conduct a sensitivity analysis.

Depending on the robustness of your financial system, you may or may not have some of the above inputs. As such, it may be necessary to first create them prior to working on the break even analysis.

Once the initial break even analysis has been done, it will just be a question of maintaining it by inputting the most recent financial information. This maintenance can be done on either a monthly or quarterly basis. The CFO/controller should set it up. Another consideration would be to "outsource" the task to a consultant. Once you get the expense info, you will need to separate the list into a Fixed Expense portion and a Variable Expense portion.

Also, as part of your break even analysis, you may want to discuss any "What if" scenarios with the Owner(s)/Management. They will be able to provide any direction you need with regards to changes in expenses going forward.

-Break Even Analysis Example-
Sly is considering starting a new business. Sly, an experienced business person and professional in his field of expertise, knows that proper planning is essential to consistent company profits. He wants to see that his company can survive before it is created.

Sly initially scours the internet for the keyword "break even calculator". Unsatisfied with the result, Sly really wants to get his hands dirty. He decides to perform his own break even calculation on paper before he creates financial models.

First, Sly estimates total revenue. He thinks about all of the products and services he would provide which create income. Now that he knows these he thinks about what he could sell them for. He does a little competitive research to find the standard market price for his products. Sly settles on this as a good point to begin his assumptions. He considers his products in reference to how many he can sell a year and decides he will be calculating break even points for each year.

Then, Sly estimates total cost. He thinks about the resources needed to conduct business. Overhead, cost of goods sold, salaries, and other factors are added. Once again Sly assumes the cost of these based on what he sees as the average cost of these resources in the market. He adds these together in regard to each year.

Sly now has his total revenue and total cost per year. Though these are estimations he is satisfied that they are an acceptable starting point. He moves on to subtract these total costs from his total revenues. Sly finds that he actually stands to loose, not gain, money from the business idea he is currently studying. Sly considers scraping his idea but decides to keep his notes and look deeper into the model. Though he has not found the results he is looking for he is pleased that he has performed a proforma break even analysis. In his current situation it is much worse than performing a post-forma break even analysis.