Putting a price on your work is probably the most intimidating task for any new business owner, regardless of whether you are selling a product or service. You can get caught up looking at what your competitors are charging or what you want to earn – you can often overlook the starting point. That is, working out what your costs are and whether your selling price can cover them.
A useful tool that I use on my clients is a ‘Break-even Analysis’.
This calculation is used to determine the number of products or services you need to sell so you can cover all your costs. When you break-even, you are neither losing money nor making money, however, all your costs have been covered.
Step 1 – categorising your costs
One of the first tasks you need to do, is to split your business’s costs under specific groupings. This enables you to look at the costs differently. Dividing costs between those that relate to producing your product/service and those that relate to running your company.
Break-Even analysis requires the costs to fall into one of two groups:
Cost of Sales / Variable Costs
These are costs that ‘vary’ according to how much you are selling. i.e. if you do not produce your product or service you will not have to pay this expense. If you increase your output these costs will go up.
Examples: hire of a venue for a workshop, wood used for making furniture, etc.
Overheads / Fixed Costs
These are costs that are the same regardless of how many items you sell. Examples are rent, membership subscriptions, etc.
This categorisation is important. Knowing what expenses are ‘general’ and what go directly into your product/service will be important if you need to cut back on spending. Understanding your costs will also help you make better decisions about whether to continue offering a product/service if the costs are too high.
This might seem to be a confusing and a daunting undertaking at first but working this out is a pivotal milestone in developing and growing your business.
You have achieved ‘breakeven-point’ when,
Total Sales = Total Costs (Fixed & Variable Costs)
Step 2 – Find the Selling Price
Setting the right price is crucial to your breakeven analysis and to your business eventually turning a profit. Your price will vary depending on what your customers are prepared to pay, however, the right price must cover all your costs.
Step 3 – Itemise all of your costs
Make sure you include all your expenses. Go through your accounts or bank statements to make sure you get them all.
It may be easier to look at an example:
Lucy runs workshops for Yoga & Herbal Remedies Training. She charges €/£/$100.00 per person to attend her 1-day events. She has gone through her accounts and has discovered the following costs:
Mobile phone bill €/£/$720 per year
Virtual Assistant €/£/$1,170 per year
Membership subscriptions €/£/$800 per year
Professional body membership €/£/$250 per year
General Facebook ads €/£/$1,200 per year
Insurance €/£/$450 per year
Total Fixed Costs for 1 year = €/£/$4,590.00
Room hire €/£/$15 per person
Herbs & containers €/£/$85 for 10 people
Step 4 – Find the contribution to fixed costs from each ticket sold:
Selling Price €/£/$100.00
Variable Costs Room Hire €/£/$ 15.00
Herbs etc. €/£/$ 8.50
Contribution per sale €/£/$ 76.50
Step 5 – Apply the formula
How many people need to attend Lucy’s workshops to cover all her costs:
Fixed Costs = €/£/$4,590.00
Variable Costs = €/£/$76.50
Fixed Costs €/£/$4,590.00 = 60 People = Break-even Point
Variable Costs €/£/$76.50
Once Lucy sells 60 workshop places she will be able to cover all her costs.
Every additional workshop or place sold above 60 people will increase profit by €/£/$76.50
It’s important to understand what the results of the breakeven analysis above are telling you. In the example above Lucy knows if getting 60 people to attend her workshops is feasible or not. To some 60 may seem low, however, if you are only starting out you might struggle to reach it.
Breakeven analysis is not a predictor of demand. Used in conjunction with other tools (customer analysis, marketing, etc) it can, however, help you make smarter business decisions.
I’m a member of the Chartered Institute of Management Accountants (CIMA) with over 20 years experience working in many different industries.
Recently I’ve taken the jump to working for myself, helping small to medium size businesses achieve growth through focusing on profit.
I love hearing about other people’s businesses, why they do what they do and what they want to achieve. My goal is to help them succeed.