Most businesses need to make a profit to survive. To do this, they must understand their costs and set prices accordingly. One way to determine whether a product or service is priced correctly is to conduct a breakeven analysis.
A breakeven analysis is a tool that can help you calculate the number of products or services you need to sell to make a profit. It considers all of your fixed costs (expenses that remain the same regardless of how many products or services you sell) and variable costs (expenses that increase or decrease depending on how many products or services you sell).
To calculate your breakeven point, Peter DeCaprio explains that you need to know two things:
Fixed costs are expenses that remain the same regardless of how many products or services you sell. Examples of fixed costs include rent, insurance, and salaries.
Your variable costs are expenses that increase or decrease depending on how many products or services you sell. Examples of variable costs include materials, commissions, and shipping.
Breakeven Point Calculation
According to Peter DeCaprio, the gross margin method uses your business’s gross margin to calculate the breakeven point. Gross margin is the difference between your product’s selling price and the COGS, which is the cost of the goods sold. It includes all direct costs of producing your product, such as materials, labor, and shipping.
To calculate your breakeven point using the gross margin method, follow these steps:
- Determine your product’s selling price.
- Determine your product’s COGS.
- Calculate your gross margin by subtracting your COGS from your selling price.
- Divide your fixed costs by your gross margin. This will give you the number of units you need to sell to break even.
Once you have determined your fixed and variable costs, you can use the following formula to calculate your breakeven point:
Breakeven point = Fixed costs ÷ (Unit Selling price – Unit Variable costs)
For instance, Peter DeCaprio owns a T-shirt company with fixed costs of $8,000. His variable cost per shirt is $8, and the selling price is $24.
To calculate the breakeven point,
Breakeven = 8000 ÷ (24-8) = 8000/16 = 500 units
How to Use Breakeven Analysis
Now that you know how to calculate your breakeven point, it’s time to put this tool to good use. Breakeven analysis can help you do several things, such as:
- Set pricing: By understanding your costs and the number of units you need to sell to break even, you can price your products or services accordingly. This will help ensure that you are making a profit on each sale.
- Make decisions about products or services: If you’re considering adding a new product or service to your business, breakeven analysis can help you decide whether it is worth pursuing. To do this, calculate the breakeven point for the new product or service. If the projected sales volume is below the breakeven point, it is probably not worth pursuing.
- Make decisions about the production: If you’re considering changing your production process, breakeven analysis can help you decide whether it is worth the investment. To do this, calculate the breakeven point for the new production process. If the projected sales volume is below the breakeven point, it is probably not worth changing your production process.
- Evaluate pricing changes: If you’re thinking about changing your prices, breakeven analysis can help you decide whether the change will be profitable. To do this, calculate the new breakeven point with the proposed price changes. If the new sales volume is below the unique breakeven point, it is probably not worth changing your prices.
Final Thoughts
Breakeven analysis is a valuable tool for businesses of all sizes. It can be used to make pricing decisions, determine how many units need to be sold to turn a profit, evaluate the financial viability of a new product or service, and much more. According to Peter DeCaprio, you can make better-informed decisions about your business’s future by understanding your breakeven point.