Writing a Business Plan Series: Week 8: Break-Even Analysis

Water Lilies at Brooklyn Botanic Garden, a photo by jbylund on Flickr.

My favorite part of the business plan: Break-Even! While at WIBO, they made a point to ensure we all understood how important break-even is. If you do not know your break-even point and prices, you are doing yourself and your business a real disservice. Knowing this critical formula will keep you from underselling your product and services, from scrambling to keep up with the competition, and from closing your doors prematurely. We spent four weeks on it!

Get your spreadsheets and calculators out. You need to know the direct and indirect costs for each and every product/service you offer and the percentages each of them represent. It's like balancing a checkbook. "How much will your business need to sell in order to cover its costs?"

Garrett Sutton describes break-even in his book as opening night in his production comparison. "The movie [has] been made. Now how many tickets [do] you have to sell to break even?" You should also do this for the month. You can use "this tool for bidding on jobs and taking on new business. You need to know where you [are] every month and you [have] to hold your margins to reach your break-even point before moving into profitability."

"The break-even analysis is a good tool for entrepreneurs because it encourages an in-depth understanding of costs. And it's good for lenders and investors because it says a lot about whether or not you, as writer of the plan, are realistic in your assumptions."

Sutton goes a step further in describing the break-even point of a business. "It is that point at which you can start to breathe a little easier. It is the point when you start to think maybe going into business for yourself was a good decision. It is the beginning of stability. It is the point too many businesses never reach. But, numerically, it is the point at which your fixed and variable expenses (including costs of sales) are met by your product and/or service sales. You won't be making a profit, but you will no longer be taking a loss." (I think another dream of an entrepreneur is to never take a loss.) "You can display this point in a number of ways in your business plan. In graph or table form, show dollars of expense compared to either dollars of revenue or units of production. In a mathematical presentation, you can find the exact break-even point with this formula:

break-even = fixed expenses + (1-variable expenses / sales)

He suggests it might be best to present this data in both formats because the graph is great since we are largely a visually based society and because bankers and other analytical types will appreciate the mathematical formula.

Here is the link to WIBO's Powerpoint presentation of break-even:

http://www.docstoc.com/docs/40162238/WIBO-Break-Even-Analysis-Primer

Do not skip this important step. You need to know your business and it's numbers. As Robert Kiyosaki says, "you need to mind your own business". Until next week...