One of the absolute scariest things about starting your own business is nailing down the most accurate break-even analysis’ possible. It’s necessary for creating a thorough business plan, which will allow you to get loans from the bank and/or funding from investors.
There are several individual factors to consider, depending on the industry you work in, and what point in the launch process you find yourself in currently. Having a break-even point you’re comfortable with will also allow you to forge ahead with confidence during those lean months.
“Fail to plan, plan to fail.” – Ben Franklin
One certainty is that if you don’t give any consideration at all to a break-even analysis, you’ll likely find yourself panhandling on the streets for spare change when your peak revenue months plummet into deep valleys of profit despair!
Break-Even Point Defined
Quite simply, a break-even point is where you go from being in the red, to the gray area between red and black – ie., profits even out expenses and you’re essentially at zero, albeit hopefully a little north of that! This number is different for every business.
Many business owners fail because they don’t bother to do an accurate analysis. Though it’s much more common with those who invest savings or loans from family into a business venture; banks will generally require well-thought-out numbers before cutting SMBs a check. Obviously, they’d lose their shirts otherwise.
How to figure out your BEP
This is simple, yet hard at the same time. Subtract all expenses from projected income. When you identify a reasonable point in the coming months where you can effectively pay all expenses with the profits from the business, you’ve broken even. At this point, you should be pilfering money into the company bank account, and figuring out ways you can use those monthly stipends to grow the business and increase profits even further.
Try to avoid approximations whenever possible, going to the extent of over-estimating if you’re unsure about certain expenses. Don’t bank on profits you’re unsure about.
Typical expenses to account for include:
- Overhead (Rent, Insurance, Utilities, etc.)
- Inventory Carry
- Development Costs (Products, Expansion, Website, etc.)
Don’t use the above list as a be-all, end all if you’re new to business. Get together with an experienced business accountant and let them audit your analysis. Or, better yet, sit down with them and do it together from the beginning.
Here’s a few more tips to help calculate the most accurate break-even analysis possible:
1. Use valley months for baseline month-to-month costs
It’s better to use the months you know will generate fewer profits and potential higher expenses to calculate an accurate break-even point. Using valley months where you’ll be making less for a baseline, will ensure you cover all expenses regardless, while also guaranteeing extra money is there when needed.
2. Make sure you include all fixed expenses in the analysis
Fixed expenses are the easiest to account for. Any business owner who gets sidelined by these expenses should be embarrassed – you can’t blame anyone but yourself.
3. Spend lots of time calculating variable expenses
These include processing fees, commission payouts, and supplies you’ll need in the coming months, such as office supplies, tools, and making reasonable assumptions about your rate of returns in the coming months. Rate of return varies widely by industry. Remember, you’re a startup – you might have to work some kinks out of your product/service before arriving at a steady rate of return (see Reducing the rate of returns).
4. Absolutely never over-estimate revenue figures
Be extremely conservative when estimating revenue numbers. Making aggressive assumptions about your product because you think it’s amazing, even when you’ve tested the market, it a recipe for financial ruin. Banks and investors will laugh at your perceived logic, and you’ll likely lose your shirt if it’s all your money on the line.
The most important advice is not to go into formulating a break-even analysis with a big head. Confidence is always necessary in business such as when dealing with clients, investors, and critics.
However, when it comes to financials, you need to have your feet firmly planted in reality. Cut projected profit estimates in half, and in many cases, double and triple many of your expenses to avoid utter financial chaos.
Learn more about forecasting revenue and expenses here.