The breakeven formula is one of the most basic formulas in accounting. It helps you determine whether your business is profitable or not, and it's a great place to start when you're trying to figure out how much you need to charge for your product or service. The breakeven formula identifies how many units you need to sell, taking into account fixed and variable costs. Make sure to understand how to calculate these metrics because you’ll add them to the pitch deck to impress investors during your fundraising efforts. The breakeven and estimated profits could also influence the safe note you draw up when contracting with financiers.
Calculating Fixed Costs
Fixed costs are those that don't change with the level of sales. The most obvious example is rent. If you have to pay rent every month, it doesn't matter how many products you make or how much you sell; the same amount of rent will come out of your pocket each month.
Examples of fixed costs are:
● Utilities – Gas, electric, internet, water, telephone, in addition to any other rates that do not change by sales volume.
● Insurance and loans – Insurance and loan repayments plus interest. Includes any equipment that is rented out that is paid periodically over time.
● Depreciation – If you buy equipment, such as office computers, this is a capital item that must be depreciated over a specified length of time.
● Payroll – For paid employees. Include pension, and benefits but exclude commission that is directly related to sales or production levels.
● Premises – Costs associated with the premises on a monthly or yearly basis, including the mortgage, interest, rent, and any other associated service costs.
It is important to create a spreadsheet that itemizes each of these expenses. When it comes to each of your company's fixed costs, you should make an effort to estimate how much money those costs will amount to on both a monthly and a yearly basis for the company's fiscal year. It’s part of learning how to calculate the breakeven point.
Variable Costs
Variable costs are the expenses that have to be paid to keep a business going. These costs change with the volume of business, so they're considered "variable." If you're a coffee shop, for example, your variable costs are the coffee beans, coffee cups, and other ingredients you need to make your coffee drinks.
Examples of variable costs are:
● Production supplies – Such as oil, are consumed based on the amount of machinery usage. Therefore, these costs vary with volume.
● Wages – Includes commission-based salaries tied to the sales or manufacturing of items and the money paid to contractors.
● Materials – The cost of the raw materials used to manufacture or create your product, such as the costs of presentation materials if running a consultancy.
● Delivery – Delivery costs are the costs associated with getting a product from the manufacturer or supplier to the customer.
● Marketing –Money spent on client acquisition. Depending on how effective your marketing is, increased expenses should result in increased sales.
It's not always easy to figure out variable costs, especially as your company grows and expands. As you grow, expand, and need more stock, you may receive a percentage off for buying in bulk.
Factor in these key variables when working out the breakeven point and you’ll exactly where your company is at, and the areas where you need to work harder to ensure consistent profits and lasting success.
BIO
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Alejandro Cremades is a serial entrepreneur and the author of The Art of Startup Fundraising. With a foreword by ‘Shark Tank‘ star, Barbara Corcoran and published by John Wiley & Sons, the book was named one of the best books for entrepreneurs. The book offers a step-by-step guide to today‘s way of raising money for entrepreneurs.
Most recently, Alejandro built and exited CoFoundersLab, which is one of the largest communities of founders online.
Prior to CoFoundersLab, Alejandro worked as a lawyer at King & Spalding, where he was involved in one of the biggest investment arbitration cases in history ($113 billion at stake).
Alejandro is an active speaker and has given guest lectures at the Wharton School of Business, Columbia Business School, and NYU Stern School of Business.
Alejandro has been involved with the JOBS Act since its inception and was invited to the White House and the US House of Representatives to provide his stands on the new regulatory changes concerning fundraising online.
