Breaking Even

Many entrepreneurs make the mistake of bringing a product orservice to the market without fully understanding the total costsinvolved and the prices they can charge. As a result, they discoverthey can't sell enough of the product or service to make aprofit.

One of the most important tools you can use to make betterbusiness decisions is the break-even analysis; it enables you todetermine with great accuracy whether or not your idea is aprofitable one. Best of all, you can use this tool to evaluateevery product or service you offer.

A break-even analysis is a simple way to determine how much ofthe product must be sold to generate a specific level ofprofitability. Keep the following in mind:

• Each business has certain fixed costs that must be paid everymonth, whether or not any sales take place.
• Each product or service has variable costs that are incurredwhen the product is produced and sold.
• There are semi-variable costs that go up or down depending onthe level of business activity.

After all costs attributable to bringing that product to marketare deducted, each product or service yields a certain amount ofprofit. This profit contribution can then be divided into the"fixed costs" to determine how many units must be sold tobreak even.

Here's a simple example of the break-even model:

The total costs of operating the business each month are$10,000. Each product the company produces can be sold for $1,000.Each product costs an average of $800 per unit to produce, sell anddeliver. The profit contribution per unit is therefore $200 each.The amount $200 is divided into $10,000 to determine the break-evenpoint. Next, $10,000 divided by $200 equals 50 units. The companymust therefore sell 50 units per month to break even, orapproximately two units per business day. Only after the companyhas sold 50 units in one month does it begin to earn a profit of$200 per unit.

Conducting an accurate break-even analysis requires a carefulexamination and study of costs and prices in your business. Youmust know what your product or service costs in total to deliver tothe final customer, as well as the price you can charge for theproduct or service. Include and deduct all miscellaneous expensesinvolved in operating your business.

To get started, analyze every product or service you produce andsell on a regular basis. Make a list of these products or services,starting from the largest volume seller. Next, calculate theaverage sales price of each unit, and then calculate the total costof each unit. Then, calculate the net profit that you earn on thesale of each unit, and calculate the cost of the investment toproduce and sell each unit. Determine the percentage ofreturn/profit that you earn from the sale of each unit.

It's important to organize each of your products andservices by priority, in terms of their contribution toprofitability. The analysis should be done on each of yourimportant products or services. Get started by determining:

• Your single most profitable product or service.
• The volume of sales of each product.
• The total profit per unit of each product sold, after deductingevery direct and indirect expense.
• The total profit contribution to the company of eachproduct.

Many entrepreneurs decide to completely discontinue a product orservice after conducting this kind of analysis. They immediatelysee that it would be better for them to invest their time and moneyin producing and selling something else.

As market conditions change and consumer desires evolve, you mayfind that a product or service that was once popular and profitableis no longer successful. It will then be time for you to beginoffering a product or service that is easier to sell, sells at ahigher price and yields a better profit.

Brian Tracy is the founder and chair of Brian Tracy International, a humanresource company based in San Diego, and one of America'sleading authorities on entrepreneurial development.