Insight: in a time of rising costs, knowing your breakeven point is essential
Our latest insight comes from Accounts and Business Services Partner Derek Shaw as he highlights why business owners need to know their breakeven point in a time of rising costs.
What is the breakeven point?
The breakeven point is a simple accounting concept; the volume of units sold or the sales a business must achieve to cover its costs. It is the point at which nil profit is made and all of the relevant fixed costs are covered. Calculating the breakeven point is equally as simple, using this straightforward formula:
Total fixed costs x 100/gross profit margin
For example, if a business has fixed costs of £100 per month and a gross profit margin of 25%, the business must achieve £400 of sales per month to breakeven. Sales less than £400 per month mean the business is making a loss. All fairly simple.
But despite the simplicity of the concept and calculation, many small business owners don’t maintain an accurate breakeven calculation. Worse still, some struggle to know their breakeven point at all.
What if I don’t know my breakeven point?
For small business owners in this situation, there are three steps to determining your breakeven point, keeping it accurate, and making it work for you.
1. Identify your fixed costs and gross profit margin
Fixed costs and profit margins can be determined via your business’s latest annual accounts or, ideally, the most recent set of management accounts. We provide comprehensive annual and management accounts preparation services for small businesses. Equipping clients with regular, accurate, and timely accounting data to help them understand all aspects of their fixed and variable costs.
2. Ensure you regularly review your breakeven point
Given the inflationary pressures that have characterised 2022, a business owner with a breakeven calculation from July 2022 is likely to have a different breakeven point if calculated using up-to-date and correct financial information. Therefore, once your breakeven point is initially calculated, it should be regularly reviewed and adjusted for increases in sales prices and costs of your business.
Accurate management accounts will assist in maintaining the efficacy of your breakeven calculation. An experienced accountant should be able to help you analyse the raw data.
3. Look ahead
The breakeven formula can be developed to enable owners to calculate what level of sales is required to make a certain profit per period. The formula is then amended to:
(Total fixed costs + required profit) x 100/gross profit margin
Using our earlier example, adding a £50 profit per month target equates to a sales value of £600 per month. Once sales have exceeded the breakeven point, the business can quickly generate profits as the fixed costs will have been met and sales beyond the breakeven point only have variable costs to cover.
Practical accounting support for small business owners
Monitoring and knowing a business’s breakeven point should be a key management tool. Used in conjunction with regular, accurate, and timely accounting data it can provide a sure foundation for business growth. Consilium Chartered Accountants support business owners and entrepreneurs with a range of accounting and business support services, including accounts preparation, annual accounts, and management accounts.
Get in touch to arrange an in-person or virtual meeting to discuss how Consilium can help you achieve your business goals.
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