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Your business breaks even when it neither incurs a loss nor earns a profit. That is, it is making just enough sales income to cover its operating expenses.

By analysing the business' expenses, you can determine the minimum level of sales that are required to achieve a certain profit level. It can also be used as a tool to calculate the minimum price to charge for your product in order to cover all operating costs.

By performing a break-even analysis regularly, you can effectively check the progress of your business in meeting your sales target or in meeting its break-even point.

Calculating the break-even point

The following calculation enables you to determine break-even point in sales dollar terms. That is, the total number of sales that need to be made in order to cover operating expenses and for the business not to make a financial loss.

• Step 1: Determine your expected sales for the financial period.

• Step 2: Categorise your expenses into fixed and variable expenses:

Fixed Expenses - expenses that do not change as your volume of sales or production changes.  E.g., Rent

Variable Expenses - expenses that change as your volume of sales or production changes.  E.g., Wages and inventory expenses.

• Step 3: Calculate the contribution margin expressed as a percentage of sales. The contribution margin represents the amount of sales available to cover fixed expenses and profit.

• Step 4: Calculate the break-even point.

To calculate the number of product units the business would need to sell in order to achieve this sales level you divide the break-even sales figure by your cost per unit of product.

The break-even analysis is a useful planning tool, particularly when approaching potential sources of financing as it provides you with an opportunity to prove the viability of your business. Further, it is an opportunity to perform a sales, expense, pricing and profit analysis for your business's products, particularly for the first few years of its operation.

For more information on break-even analysis visit Small Business Victoria to download a brochure on how to perform a break-even analysis.