Break-even is the point when income matches expenses. Knowing your break-even point shows how much revenue you need to equal and surpass expenses. To determine your break-even point, you need to understand a few terms.

Fixed costs are the costs that do not change no matter how much revenue you earn. Items like rent, utilities, management and administrative wages, and insurances are considered fixed costs.

Variable costs are those that are directly related to the products or services you sell. They include raw materials, direct labor (manufacturing labor or service labor), and the cost of items purchased for resale.

Contribution Margin is calculated by subtracting variable costs from revenues.

Break-even = Fixed Costs/Contribution Margin

Below are three examples of break-even analysis for different types of business.

Manufacturing company:

Fixed costs                = $60,000 per month

Variable costs            = 30%

Sale price per item    = $50

Contribution margin = $50 – 30% = $50 – $15 = $35

Break-even                = 60,000/35

                                  = 1,715 items or $85,714.50 in sales

This company needs to sell 1,715 items per month at $50 each to break even.

Restaurant:

Fixed costs                    = $9,000 per month

Variable costs (food)     = 40%

Average bill per person = $50

Contribution margin     = $50 – 40% = $50 – $20 = $30

Break-even                    = $9,000/30

Break-even                    = 300

The restaurant must serve 300 people in a month to break even. That equals about 10 people per day.

Service provider:

Fixed costs                 = $4,000 per month

Variable costs (labor) = 50%

Sale price per hour    = $100

Contribution margin  = $100 – 50% = $50

Break-even                 = 4000/50

Break-even                 = 80 hours of services sold or $8,000

This service provider needs to sell 80 hours of services each month to break even.

Why is break-even analysis so important?

1. Knowing your break-even helps you determine if a business can be profitable. If you need to charge $100 per unit to cover your fixed and variable costs but competitors are charging an average of $60 per unit for similar items, you know you are not going to be successful with this set of circumstances. But if your products are better quality and justify the higher price, then it could work.

2. Determining your break-even forces you to consider all your variable and fixed costs. A manufacturer might be able to negotiate better prices for raw materials; a restaurant might consider other sources for food, you might need to reduce the number of employees, or you might need to shop around for lower insurance premiums.

3. Knowing your break-even point can help you discover the items/services that bring the highest profits. Doing a break-even analysis for the individual items you sell will show you where you make the most money. Sometimes it will tell you if you need to eliminate certain items or services.

4. Similarly, a break-even analysis will help you decide if a new product or service will be profitable.

5. Break-even analysis is necessary if you want to attract investors. This shows investors that you understand your business numbers and will help you substantiate any claims you make about profitability.

A break-even analysis should be done for every business at least once per year, along with a market analysis. Cost increases in materials, labor, rent, insurances are a given. Any needed sales price changes can be determined by looking at the break-even, along with considering competitors’ pricing.

A good accountant should be able to work with you on your break-even analysis. If your accountant does not provide one, ask for it!

There are three critical statements that should be included in every business reporting package: the Balance Sheet, the Income Statement, and the Cash Flow statement.

The Income Statement, sometimes called the Profit and Loss Statement, is a record of the revenues and expenses over a certain time period; monthly, quarterly, or annually.  Remember that an Income Statement is a record of past events. It is used to see what happened in the past, not what will happen in the future.

While an Income Statement shows the profitability (or losses) of a company, it does not show the cash flow or position. A company may show a profit on the Income Statement, but if customers are late in paying, you prepay expenses, or you have loan payments, your cash position might be in trouble. That is why you need all three statements for a good evaluation of the health of your company.

The Income Statement is used by the owner of a business to determine how profitable the company was over a specific period of time. It is also used by investors to verify the company will provide a return on their potential investment. Finally, this statement is used by banks and other lenders to ascertain the ability of the company to repay any loans.

The Income Statement should be prepared monthly or at the very least, quarterly. Banks and investors will often ask to see prior year income statements to compare the growth and profitability of your company over time. The income statement is also used by your CPA to prepare your tax returns.

The Income Statement has three or four main components: revenues, cost of sales, general and administrative expenses, and other income/expense.

Revenues:

These can be detailed by sales categories. Products and services can be broken down by type.

Cost of sales (COS) / Cost of goods sold (COGS):

1. If you manufacture products for sale, this includes the costs of raw materials, direct labor, overhead allocation, and freight costs.
2. If you purchase products for resale, the costs of these products and related freight charges are included, as well as any inventory storage costs.
3. If you sell services, your costs of labor for these services are included. Also include any benefits for this labor.

Gross Income = Revenues less COGS

Selling, General and Administrative Expenses (SG&A):

Salaries and wages (non-manufacturing), payroll taxes and benefits, rents, telecommunications, advertising, insurance, supplies, depreciation

Operating Income = Gross Income less SG&A expenses

Other Income (Expense):

Interest income, interest expense, gain or loss from sale of assets, bad debt expense

Earnings before taxes (EBT) = Operating Income plus Other Income less Other Expense

Provision for Income Taxes

Net Income (Loss)

A sample Income Statement:

Contact your accounting professional if you have more questions about financial reporting for your business.