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 several different legal structures in which you can form your business. The four main types are listed here:

Sole proprietor

A sole proprietor is someone who owns an unincorporated business alone.  Basically, you are your business—there is no separate business entity.  You are automatically considered a sole proprietor if you conduct business but don’t register as any other type of business structure. You are personally responsible for all liabilities of your business.

A business run as a sole proprietorship does not pay separate income tax. The income and deductions of the business are reported on a Schedule C, Profit or Loss from Business which is filed with your Form 1040 each year. You will also need to file Schedule SE, Self-Employment Tax. Additionally, you need to pay estimated taxes on a quarterly basis using Form 1040-ES, Estimated Tax for Individuals. Consult with a tax professional to determine the appropriate estimated tax payments.

Partnership

A partnership is an agreement between two or more people to participates in a business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership must report the business income, expenses, gains, and losses from operations on Form 1065, U.S. Return of Partnership Income, but does not pay income tax. Instead, the profits or losses are passed through to the partners, each of whom includes his or her share on his or her Form 1040. Additionally, each partner needs to file Schedule SE, Self-Employment Tax, and pay quarterly estimated income taxes.

There are two common kinds of partnerships: Limited Partnerships (LP) and Limited Liability Partnerships (LLP). Limited Partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also have limited control over the company. Profits are passed through to personal tax returns, and the general partner is the only one who must pay self-employment taxes.

Limited Liability Partnerships are similar to Limited Partnerships but give limited liability to every owner. An LLP protects each partner from debts against the partnership in that they aren’t held responsible for the actions of the other partners.

Limited Liability Company (LLC)

An LLC is a business entity separate from the owners, and the owners usually do not have personal liability in case of bankruptcy or lawsuits.  Owners of an LLC are called members; members of an LLC may be individuals, corporations, or other LLCs. Most states allow “single-member” LLCs, and there is not a maximum number of members.

Depending on the number of members and the business considerations, an LLC can be treated as either a corporation, a partnership, or as part of the LLC’s owners tax return (a disregarded entity). A single-member LLC is treated as a “disregarded entity” unless it files Form 8832 and elects to be treated as a corporation. An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation.

Corporation

A corporation is a separate entity from the owners, who are called shareholders. Corporations provide the strongest protection to its owners from personal liability, but the cost to form and maintain a corporation is higher than other structures.

Any profits of a corporation are taxed separately from the owners. A corporation must file a Form 1120, U.S. Corporation Income Tax Return. Any profits paid to shareholders are called dividends and shareholders must pay income tax on any dividends they take. The corporation does not get a tax deduction when it pays dividends, consequently shareholders face “double taxation.” Additionally, shareholders cannot deduct any losses of the corporation.

S Corporation

An S Corporation is a corporation that elects to pass the business income and deductions through to the shareholders for federal tax purposes. This allows S Corporations to avid the double taxation on corporation income. To qualify for S Corporation status, a corporation must meet the following requirements:

• Be a domestic corporation
• Shareholders cannot be partnerships, corporations or non-resident aliens
• Have no more than 100 shareholders
• Have only one class of stock

 

Deciding which business structure to use for your company can be confusing. Consult with a trusted business professional if you are not sure of the best structure for you.