Knowing breakeven is key for any start-up business
Anyone who has started a business from scratch knows how hard it is in the early months (or even years). Lots of businesses seem to fail too in these early times. Why? Well, there are many reasons from just bad timing, to poor marketing, poor quality and so on. There is also the possibility that the business simply did not understand its costs structure and how this relates to the volume of sales needed to make a profit.
The US Small Business Administration (and similar organisations world-wide) provide good advice for start-ups. One key concept on understanding costs and volumes is called breakeven. This simply means the output level at which your business neither makes a profit nor loss. To keep it simple, if a business knows its start-up costs and running costs for the first year, it can easily work out the level of sales required to breakeven – this output level is known as the breakeven point. To work out the breakeven point, you need to separate variable costs and fixed costs. Fixed costs remain the same regardless of how much your business sells (e.g. rent) and variable costs change as the output grows (e.g. labour costs , shipping cost, material costs). For breakeven, the sales value less the value of variable cost must be equal to fixed costs; any surplus is a profit, any deficit a loss. Doing this quick sum could save many businesses from going under. In fact, as a management accountant I would suggest a breakeven calculation is included in all business plans. I would say that, but why go into business to lose money? Or at least know when you will start to make money?