In the second part of our series on some of the tools that can help you review the health of your business, our Chief Accountant Emily explains the break-even point.
So what is the break-even point?
In a nutshell, the break-even point is the point where a business’s costs are equal to its sales. When an accountant checks through your financial information it’s likely they’ll use this to see if your business is healthy.
The break-even point is also often used in planning. If you have a profit and loss account from a previous period, and you know that your costs are about to increase, perhaps because you’re taking on a new member of staff or renting a larger workshop, you can use the break-even point to make sure your income from sales will still cover your increased costs.
You might also want to allow for reduced sales. For example, time spent training a new staff member is time you can’t charge your clients for.
Calculating your break-even point
So how do you work out your business’s break-even point?
Here’s a profit and loss account generated in FreeAgent.
The gross profit margin in this example is 88%, which is worked out as (sales less cost of sales) / sales = (£61,558 - £7,608) / £61,558.
To work out your business’s break-even point, add up all its overheads, and divide that figure by the gross profit margin. Remember not to include cost of sales, because you included those in the gross profit calculation.
For this business, (£19,358 + £11,454 + £2,299 + £59 + £2,013) / 88% = £39,981. This is how much the business needs to earn in sales to break-even. The business has earned almost half as much again and therefore has nothing to worry about in the short-term, and could potentially plan growth, for example an office move or recruitment.
In the third and final part of this series, Emily looks at “debtor days”, a ratio that indicates how quickly your customers pay you.