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Breakeven analysis is a tool used to determine when a business will be able to cover all its expenses and begin to make a profit. For the startup business it is extremely important to know your startup costs, which provide you with the information you need to generate enough sales revenue to pay the ongoing expenses related to running your business.

A startup business owner must understand that $5,000 of product sales will not cover $5,000 in monthly overhead expenses. The cost of selling $5,000 in retail goods could easily be $3,000 at the wholesale price, so the $5,000 in sales revenue only provides $2,000 in gross profit available for overhead costs. The breakeven point is reached when revenue equals all business costs.

To calculate your breakeven point you will need to identify your fixed and variable costs. Fixed costs are expenses that do not vary with sales volume, such as rent or administrative salaries. These costs have to be paid regardless of sales and are often referred to as overhead costs. Variable costs vary directly with the sales volume, such as the costs of purchasing inventory, shipping, or manufacturing a product.

The formula for determining your breakeven point requires no more than simple arithmetic.

Definitions

Variable unit cost

Cost associated with producing an additional unit.

Fixed cost

The sum of all costs required to produce any product. This amount does not change as production increases or decreases.

Expected unit sales

The number of units that are expected to be sold.

Price

Price you will be able to receive per unit.

Total variable costs

The product of units produced and variable unit cost (example 10 units at $5 variable cost produces a total variable cost of $50).

Total costs

Sum of fixed costs and variable costs.

Total revenue

Product of price and expected sale unit sales (example 10 units at $10 equals $100 total revenue).

Profit

Total revenue minus total costs.

Breakeven

Number of units required to sell to make a profit of zero.