What Is a Break Even Analysis and Why Your Business Needs One
When you’re running your own online store, there’s a lot to keep track of. You need to watch inventory levels, monitor product quality, and ensure that customer service is great. You also need to stay on top of your finances, including ensuring that you’ll have a strong cash flow to stay in business.
When you’re making financial decisions for your business, one of the reports that you’ll want to look at closely is your break even analysis. It can help you assess how much room you actually have in your budget to spend, and how you should price your products.
In this post, we’re going to discuss everything you need to know about a break even analysis, including:
What is a break even analysis?
Your break even analysis helps you determine how many products you need to sell in order to cover all of your business costs and make a profit. You do this by comparing your fixed and variable costs against your profit.
Your break even analysis is a crucial figure when it comes to the financial health of your business. It helps show you how much you can afford to spend on “fluctuating” costs, like whether or not you can add an additional team member to your staff, or if you could sustain through unpredictable costs that are common with eCommerce businesses like returns, lost shipments to customers, and damaged inventory.
Your break even analysis can also show you how much you need to sell in order to keep your business financially viable, and at what margins and price points you need to reach in order to hit the break even point where you can make a profit.
Because this figure is so essential and will impact how you price your products, you want to conduct a break even analysis before you even start selling to consumers. That being said, you’ll also want to run recalculations as your business grows and your costs and revenue shift.
How to calculate your break even analysis
Let’s take a look at how to calculate your break even point with the break even analysis formula.
First, it’s important to know the following definitions:
Fixed costs. Fixed costs are those that you consistently have each month. You may pay $500 a month in storage fees for your products, for example, or $300 a month for a virtual assistant to help you manage sales.
Variable costs per product. Your variable product costs are the costs associated with individual products. They go up as you manufacture or sell more products. A variable cost, for example, would be $5 for every pair of shoes that you sell for the manufacturing materials.
Contribution margin. The excess between a product’s selling price and their total variable costs. If your product is $100 and your variable costs are $80, your contribution margin is $20.
Contribution margin ratio. This is the ratio of your variable costs to your product. If your product is $100 and your variable costs are $80, your contribution margin ratio is 20%.
Profit earned. This is the profit you earn after you’ve reached the break even point.
Keep in mind that some invoicing and eCommerce platforms can help you find some of this information. Wix, for example, has an integration with Quickbooks, which allows businesses to track and monitor all of their current expenses. This prevents business owners from forgetting about costs.
How to calculate a break even point
This formula will help you determine how many units you need to sell in order to hit your break even point.
First, calculate your contribution margin:
(Price of Your Product) — (Variable Costs) = Contribution Margin
If you’re charging $100 for your product and each one costs you $40 to make, your contribution margin is $60.
Then use the following break even point formula:
(Fixed Costs) / (Contribution Margin) = Break Even Point
If you have $200 in fixed costs per month and your contribution margin is $30, you’ll divide 200 by 30. This will give you an answer of 6.6, telling you that you need to sell 6.6 products in order to break even. Since you can’t sell two-thirds of a product, in most cases you’ll need to sell 7.
The costs that you need to consider
When conducting a break even analysis, your projections are only going to be accurate if you’re taking all of your costs into account.
You don’t need to only consider direct product manufacturing costs, which is a common mistake some businesses make. You also want to consider any of the following that are applicable to you:
The cost of warehouse storage
Costs associated with distribution and shipping to customers
Product packaging, including branded boxes, packing materials, price tags, and brand tags
Ongoing business fees associated with licenses and permits
Taxes
Costs of needed to run your business, including a fee for your accountant, SaaS software, and the eCommerce solution you use
Your salary, any team member’s salaries, and fees for third-party contractors
Costs associated with marketing
What does a break even analysis look like?
Let’s take a look at a break even analysis example in action.
Say that you sell handmade scarves that you’ve knitted yourself. You plan on charging $20 per scarf for the business that you’re launching soon. You can run a break even analysis to make sure that this will be profitable. You’ll quickly realize, though, that $20 isn’t enough.
The costs don’t just involve the $5 worth of raw materials that you use to manufacture each scarf, but the additional variable costs of $8 for shipping, $2 for product packaging, $6 in marketing, and $2 for credit card fees. It costs you $23 just to produce each scarf, making $23 your variable cost.
If you were to only charge $20 in an attempt to edge out the competition, you might successfully drive sales, but you’ll actually be losing money for each scarf sold. And that’s before you account for fixed costs, like business licenses, website fees, and paying your own salary.
Let’s say that you have the following fixed costs:
$100 per month in business license fees
$10 per month for site hosting
$50 per month for community marketplaces that allow for sales
$100 per month for an accountant
Your fixed costs are $260 per month.
Let’s say that after realizing $20 is too little, you choose to sell your scarves for $35 apiece.
Following the formula above, you’ll take the price of your product ($35) and subtract their variable costs ($23), giving you a contribution margin of $12.
You’ll then calculate your break even point.
Take your fixed costs of $260 and divide it by the contribution margin of $12. At this product price point, you’ll need to sell 21.6 scarves per month to break even, meaning that you’d actually need to sell 22. And that’s just to break even.
How to use our break even analysis template
If you’re interested in conducting a break even analysis and don’t have access to tools that can automatically do it for you, you can use a template like ours. To use our break even analysis template, make a copy of the Google Sheets document and add your own business information. You’ll need to account for all of your individual business’ expenses, which will likely mean adding and removing categories as needed.
You’ll be able to see how changing product prices influences the number of units you need to sell to cover your costs, and how varying costs play a role in your profit.
Why your break even analysis is so important
Your financial health is crucial for the success of your business and creating an accurate break even analysis is an important part of that.
Remember that 82% of small businesses will ultimately have to close their doors permanently because they have issues related to cash flow.
Your break even analysis will help you know exactly what your standard costs are and what you need to be charging and making. This makes your goals clearer so that you can work towards them.
Knowing how much you need to charge in order to make a profit will make all the difference in your business’s potential growth and scalability. It can also help you assess how much profit you can reasonably expect to make once you understand the safety margins involved (or how much of a gap you have between financial gains and financial loss).
When you’re trying to set a target revenue, a detailed break even analysis prevents you from accidentally underestimated your costs, ending up in a financial black hole. You’ll avoid overspending or undercharging, because you’ll know exactly how much room you have in your budget after established costs are considered.
As you’re submitting your business plan to investors and lenders, this report can show potential financiers that you’re a strong candidate by displaying a firm grasp on your financial projections. This can help you secure the financing that you need.
How to use a break even analysis to price your products
Your contribution margin is key when you’re using a break even analysis to price your products.
You don’t just want to break even, because then there’s no real revenue to take home at the end of the day. This prevents the growth of your business, and even one unexpected expense can put your cash flow in the negative.
When you’re pricing your products, the higher your contribution margin is, the better off you’ll be. While it depends on the industry, a contribution margin of around 10-20% is a safe bet. You almost never want to be below a contribution margin of 10%, because it can hinder your business’ financial success long-term.
While higher contribution margins are attractive (and some businesses are definitely able to reach them), remember that you need your prices to be competitive. Unless you’re truly offering a first-in-your-field, groundbreaking product or you have an established luxury name attached to your brand, you likely won’t be able to charge $150 for something that your competitors are only charging $50.
Certain competitive advantages may allow you to increase your pricing past your competitors. These may include the following:
Higher quality items
Sustainably-made or eco-friendly items
Offering additional features that your competitors don’t
Keep in mind that as you expand your product offerings, you want your contribution margins as a whole to be in the positive. Some businesses may have very low contribution margins on some products, but high contribution margins on others.
Microsoft, for example, has extremely low contribution margins when they sell game consoles themselves. That being said, their contribution margins on gaming pass subscriptions, accessories, and games are much, much higher. They break even on the consoles, but have incredibly high contribution margins on the games, which yields a net profit overall.
How to leverage your break even analysis moving forward
One you have a break even analysis (and update it as you scale), there are several ways that you can leverage it moving forward.
In addition to potentially adjusting the price of your products, you may realize that there is either more room in your budget to scale, or places where the budget should be trimmed.
If your contribution margins are a little too close for comfort, you can look for easy places to cut costs. You might realize that reducing one of your SaaS tools to a lower-cost plan is a good option, or find that ordering some supplies in bulk can provide significant savings over a year-long period.
Alternatively, if your contributions are high and you want to grow your business faster, you can reinvest more of your revenue into marketing campaigns. You could pay for sponsored posts from Instagram influencers, or run pay-per-click (PPC) campaigns to drive quick sales.
The limitations of a break even analysis you need to know
A break even analysis is an incredibly useful tool when you’re making financial decisions.
That being said, it does have its limitations.
When pricing your products, for example, you don’t want to exclusively focus on contribution margins. You need to look at what else is happening in the market, and what your audience is willing to pay.
A break even analysis is also simplistic, so while it can give you a big-picture view, it sometimes misses the finer details that can make a big difference. This may include:
Fluctuating customer behavior
Shifts in market trends
Seasonal demands
The impact of sales pricing or discounts
While you can use it for financial projections, to help with product pricing, and to win over investors, remember that it’s only one report of many that you should be taking into consideration.
Final Thoughts
Staying on top of your business’s financial status is an essential part of immediate and long-term success. Your break even analysis can be a useful tool at all stages of your business, including before you even officially launch. Ensuring that your product contribution margins are high enough to yield a profit is crucial, and the break even analysis can help with that.
As your business grows and evolves, you’ll want to reassess your break even analysis. Fortunately, there are some tools that can help with this. Wix, for example, has finance reports and analytics to track sales revenue, and our integration with Quickbooks allows you to track expenses, too.
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Daniel Clinton
Managing Editor, Wix eCommerce
Daniel is the Managing Editor at Wix eCommerce, where he uses his experience as a merchant, journalist and marketer to create content that helps online businesses grow.
