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The break-even point is the combination of key values that will show you how much monthly income you need to meet to cover all the fixed and variable costs of your company. It is a calculation to know from what point the organization begins to obtain profits.
When to use the break-even point?
Estimating the break-even point as accurately as possible is the best way to know if the company's business plan will hold. In other words, you'll find out exactly how much you need to sell each month (and at what price) to break even.
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How to calculate the break-even point?
Before you begin, you need to determine some starting values, such as:
1. Unit price per sale: how much you charge for each product or service. Here, for example, we enter a value of $100. How many must we sell to be able to cover our expenses?
| Product | Sale price (P) | Break-even |
| Hub 115 mm diameter 1" | $100 | PE = FC / (P - VC) |
2. Variable costs per unit (VC): it is an expense that is applied to the product or service. Next, we determine the value of the costs of raw materials, taxes, commissions, and others. We arrived for $71.00 per unit.
| Raw material | Commissions | Taxes | Other expenses |
| 15 | 3% | 15% | 10 |
3. Fixed costs per period: those costs that are not related to the production, but are necessary for the maintenance of the company. Salaries, water, electricity, and telephone are just some examples.
| Fixed costs (FC) | Price |
| Salaries | $ 35000 |
| Services (Water, electricity, etc) | $ 1500 |
| Phone and internet | $ 2900 |
| Marketing | $ 4000 |
| Other expenses | $ 3200 |
FC/(P-CV) = PE
46600 / (100-71) = 1607 u.
Our balance point is 1607, that is, we need to sell 1607 units to achieve a balance in our company; all the units that we sell apart from that number will be part of our profit.
Why calculate the break-even point?
The analysis of the breakeven point allows the company to make projections knowing the cost-volume-utility relationship of its products, this is because the contribution margin that each product has indicated the strategy that the company must follow:
- The higher the contribution margin ratio, the lower the volume of sales that the company must make to cover its costs and start generating profits.
- In turn, this indicates that products with a lower contribution margin should have a higher turnover, which allows for covering fixed costs and achieving a profit.
Based on the above, the company can make decisions regarding the price and costs of its products:
You can carry out simulations to determine to what extent it is feasible to reduce the price of your products without generating losses, or on the contrary if you must increase the price of these to cover your fixed costs.
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At the same time, you can determine if it is necessary to review your fixed costs, in case the contribution margin is not enough to cover them.
What can you do to improve your company's break-even point?
Only two big decisions can be made: either increase margins or reduce production costs. Here are some tips to keep in mind before making a decision:
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1. Raise your prices. The first "textbook" strategy is to raise the price of your product or service. Provided, of course, that it has sufficient differentiation to do so. Before making a decision, analyze the pricing policy of the companies that are already operating in the sector in which you want to enter (and which are going to be your competitors) and what were the results they obtained: Did they start a war of prices? How did the public respond to your prices? Study how consumers behave in your sector and what weight quality has for them: Is this the main element of judgment at the time of purchase? You can increase the price and reduce distribution costs.
Do not do it if: “In your sector, price prevails over quality”.
2. Make fewer discounts. If you have a quality product, you don't have to start your business with a pricing strategy based on a discount policy just for the sake of attracting customers. You need to design a discount strategy that is very selective with your customers, rewarding only those who are loyal to you from day one with lower prices and opportunities. Replace discounts with loyalty cards. Trust in the quality of your product and focus on making it better known.Do not do it if: "You will not be able to invest money in advertising."
3. Differentiate your product. First, you must have a good product, but then you have to differentiate it as much as you can from the offer in your sector. It's about making your product less price sensitive. To do this, before entering the market, in addition to offering a good product or service, even if you have a competitive price, it is a good idea to make an extra effort to differentiate it even more. Product diversification would also come in here, redirecting your product to different specific niches.Do not do it if: “The sector has a rigid cost structure”.
4. Improve conditions with your suppliers. The goal is to lower rates or achieve better delivery times from suppliers (by improving the conditions of the service or expanding it, you can save indirect costs). This strategy will depend on the relationships you establish with the companies that are going to supply you with products or services.Do not do it if: “You are not willing to pay them more when it goes well for you”.
5. Outsource what you can. From business areas in which you are not an expert (such as administrative management, communication, or logistics) to traditional fixed expenses such as the office or computer equipment or a fleet of vehicles or labor (through employees or external consultants for certain areas of your business), passing through the production of certain processes of your product or service (inside and outside the country).Do not do it if: "It is an activity that you should control, even if you save."
6. Make alliances. You can study different forms of business cooperation: alliances, franchises, etc. It is about looking for partners to be able to reach investments or strategies that you could not obtain with your investment and in which both the costs and the risks are shared, in most cases, in equal parts. It is not just about forging strategic alliances when offering your products or services outside the country, but about reaching agreements to attract consumers or to offer them some added value. You can consider offering your services for free to another company in exchange for theirs.Do not do it if: “The other company does not provide you with added value”.
7. Eliminate unnecessary processes. Dispense with processes and intermediaries that do not add value to your product or that can be replaced by other providers that pay you a lower cost. Here a good selection of suppliers plays in your favor.Do not do it if: “The quality will be affected”.
8. Be patient. Whenever you are going to consider investing in a fixed cost, calculate your break-even point again. Perhaps a new machine has come out with which you could produce more, but you are not ready to produce more. When in doubt, bet on variable costs.Do not do it if: “You do not have a sufficient production volume to assume the new cost”.
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