If you don’t have an MBA, understanding the basics of your company’s finances can be, to put it lightly, a tad intimidating. There are lots of terms to understand — some of which you can punt on (EBITDA, for example) and some of which you can’t. Your break-even point is among the latter.
For this week’s Starting a Business installment, we’re taking a look at the break-even point — what it really is, why it’s important, and how to calculate yours.
CALCULATING YOUR BREAK-EVEN POINT
What is a break-even point?
Let’s start at the beginning, with the “what.” Your break-even point is that magical place where the money coming in equals the money going out, where you cross over from losing money to making money. Fairly self-explanatory.
But more specifically, understanding your break-even point means knowing how many products/services you need to sell in order to cover your monthly expenses. Not a date, and not a dollar amount, but a number. “I need to sell 2,500 of my hand-knitted scarves a month in order to break even. Any more, and I’m making money. Any less, and I may have to dip into my savings.” That’s a break-even point.
What about start-up costs?
Before we dig in to calculating your break-even point, let’s acknowledge something we’re not discussing: start-up costs. Getting a business going often requires a big infusion of cash up front to cover expenses. In the case of opening The Skillery, our start-up costs included furniture, paint, a printer, decor (like our main room artwork from Steric Design) and the like. We’ll need to be profitable for a long time in order to recoup the money we had to lay out to open the doors.
But that’s not what we’re talking about here. Here, we’re trying to understand how many members we need paying monthly dues at The Skillery in order to pay our ongoing monthly bills: rent, electricity, Internet, heat, etc. That’s our break-even point.
Figuring out your number
OK, time to calculate. First, we start with costs — the money we pay every month for all kinds of things. There are two types: fixed and variable costs.
Variable costs are incurred only when we make a sale. A credit card processing fee when we swipe a customer’s card. A T-shirt we give to new members. At The Skillery, variable costs are pretty low — if we pretended (for the sake of this blog post) that our members pay $125 per month, our variable costs are about $5 per transaction. That leaves gross profit on each sale at $120. Not too bad. (Gross profit is your price minus variable costs.)
But then there’s our fixed costs — things we pay for whether we make a sale or not. Heat. Rent. Electricity. Salaries. Even if we have zero members at The Skillery, we still have to pay those bills. At The Skillery, we figure our fixed costs are roughly $12,000 per month.
So, that leaves us with our break-even point question: How many sales do we need to make — how many memberships giving us $120 gross profit do we need to bring in — to cover our costs? The answer: fixed costs divided by gross profit, and we’ve got our break-even point.
So, for us: break-even point = $12,000 / $120. We need to have 100 members in order to cover our expenses each month.
Caveat: our picture is a really a little more complicated, and yours probably will be too. We have multiple membership levels at different rates, and other “products,” like classes and workshops. Odds are you’ll have a similar span of offerings that figure into calculating your profits. But as far as a basic understanding (and for the purposes of this post), that’s the gist. (Our CO.STARTERS at The Skillery cohort members are digging deeper into concepts like this right now, and if you’d like to get more in-depth, we have several new sessions coming up, including CO.STARTERS for Food Entrepreneurs.)
Feel like you have a basic sense of the break-even point? Still have questions? Hit us up.
Next week, we’ll stay in the world of dollars and cents, and talk about financial projections. (If you’d like to check out past posts in this series, check out all the Starting a Business posts we’ve shared so far.)