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The
Break-Even Analysis helps the business owner determine the success of
a business before it begins. It describes the number of units of a product
or how many hours of a service must be sold to break even or to make
a profit, or the effect that changing a product's price or reducing
expenses has on profitability. This simple formula determines the break-even
point or the point where the business will begin to show a profit: Let's look at Jean whose experience with craft fairs has helped her decide to make and sell earrings. We will calculate her fixed expenses, gross profit, and the break-even point. Here are her variable and fixed expenses:
Based on her variable expenses, Jean will certainly charge at least $13.50 for a pair of earrings, but how much more should she charge to cover her monthly fixed expenses and make a profit? She must first calculate her gross profit, then determine her break-even point. Her research of the local market showed that comparable earrings sell for $20-30 per pair, so she calculates her gross profit based on three sales prices between $20 and $30 using the following formula: Price
- Variable Expenses = Gross Profit per Unit
Clearly, by charging
more Jean earns more money to meet her projected monthly fixed expenses
($945), but she must calculate
At a selling price of $20, Jean must sell 146 pairs of earrings per month to break even, at $25, she must sell 83, and at $30 she must sell 58. In a month when she sells more than the break-even number for her chosen price, she makes a profit. In a month when she sells fewer pairs, she loses money. Determining a Sales Goal Based on Desired ProfitIn addition to
breaking even, Jean wishes to earn $150 profit each month to invest
in upgrading her equipment and buying a van. She can calculate how many
pairs of earrings over the break-even point she must sell by using this
sales goal formula: Here are Jean's calculations:
If Jean sells her earrings for $20 she has to sell an additional 24 pairs over her break-even point to make a $150 profit, at $25 she must sell an additional 14 pairs, and at $30 she must sell an additional 10 pairs. PricingOnce variable costs, fixed costs, gross profit, the break-even point, and sales goals for profits are calculated, the consumer can decide on price. The numbers alone will not dictate the right price. The consumer's previous work on positioning and competition will help set the price. He or she must also consider personal and long-term business goals. For example, how much of a personal draw and/or profit does the business owner need to make a living? Pricing a Service
Pricing a service is not always as mathematically clear as pricing a
product. For example in a home-based accounting or business management
business, materials, labor, and overhead costs may be ill-defined. In
such cases, prices are for time and generally the business owner must
charge close to the prevailing rate for the area. The potential business
owner's research must investigate industry charges for comparable services,
method of billing - per hour or per project, and who pays for materials
- the customer or the business owner. Evaluating the Break-Even AnalysisAlthough a consultant should have guided the business plan's development, you as the VR counselor must review it to determine whether your agency will provide support. While evaluating the plan's potential, consider:
Chapter 6 Business Plan Study Guide: Break Even Analysis
Study
Guide Answers: Chapter 6 - Break Even Analysis © July 1998, 1st Revision June 1999, 2nd Revision February 2001 |
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