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Break-Even Analysis A break-even analysis shows you when you've started to make a profit.

One useful tool in tracking your business's cash flow willbe break-even analysis. It is a fairly simple calculation and canprove very helpful in deciding whether to make an equipmentpurchase or just to know how close you are to your break-evenlevel. Here are the variables needed to compute a break-even salesanalysis:

  • Gross profit margin
  • Operating expenses (less depreciation)
  • Total of monthly debt payments for the year (annual debtservice)
    Since we are dealing with cash flow and depreciation is a noncashexpense, it is subtracted from the operating expenses. Thebreak-even calculation for sales is:
(Operating Expenses + Annual Debt Service)/Gross ProfitMargin = Break-even Sales

Let's use ABC Clothing as an example and compute thiscompany's break-even sales for Years 1 and 2:

Break-even Sales for Year 1: ($170,000 + $30,000)/.25 =$800,000
Break-even Sales for Year 2: ($245,000 + $30,000)/.30 =$916,667

It is apparent from these calculations that ABC Clothing waswell ahead of break-even sales both in Year 1 ($1 million sales)and Year 2 ($1.5 million).

Break-even analysis also can be used to calculate break-evensales needed for the other variables in the equation. Let's saythe owner of ABC Clothing was confident he could generate sales of$750,000, and the company's operating expenses are $170,000with $30,000 in annual current maturities of long-term debt. Thebreak-even gross margin needed would be calculated as follows:

($170,000 + $30,000)/$750,000 = 26.7%

Now let's use ABC Clothing to determine the break-evenoperating expenses. If we know that the gross profit margin is 25percent, the sales are $750,000 and the current maturities oflong-term debt are $30,000, we can calculate the break-evenoperating expenses as follows:

(.25 x $750,000) - $30,000 = $157,500

Excerpted from Start Your Own Business: The Only Start-UpBook You'll Ever Need, by Rieva Lesonsky and the Staff ofEntrepreneur Magazine, © 1998 Entrepreneur Press

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