How can you tell if your business idea will be profitable? A break-even analysis shows you the amount of revenue you'll 
need to cover your expenses before you can make a profit. To perform a break-even analysis, you will need to know your expenses and sales revenues.
- Fixed costs. Fixed costs (sometimes called "overhead") don't vary much from month to month. They include rent, insurance, utilities, and other set expenses.
Example: Mary recently opened a dress studio. She designs formal dresses and suits for women. Mary's fixed costs are $6,000 a month.
- Sales revenue. This is the total dollars from sales activity that you bring into your business each month or year. To perform a valid break-even analysis, you must base your forecast on the volume of business you really expect--not on how much you need to make a good profit.
Example: Mary realistically believes she can sell 25 dresses each month. She charges $300 for each dress, so her monthly sales revenue is $7,500.
- Average gross profit for each sale. Average gross profit is the money left from each sales dollar after paying the direct costs of a sale. Direct costs are what you pay to provide your product or service.
Example: Mary pays an average of $100 for goods to make the dresses she sells for $300. Therefore Mary's average gross profit is $200 for each sale.
- Average gross profit percentage. This percentage tells you how much of each dollar of sales income gross profit is. To calculate your average gross profit percentage, divide your average gross profit figure by the average selling price.
Example: Mary makes an average gross profit of $200 on dresses that she sells for $300, so her gross profit percentage is 66.7 percent ($200 ÷ $300).
Calculating Your Break-Even Point
Simply divide your estimated fixed costs by your gross profit percentage to determine the amount of sales revenue you'll need to bring in just to break even.
Fixed Costs ÷ Gross Profit Percentage = Amount of Sales Revenue Needed to Break Even
Example: Mary's fixed costs are $6,000 per month and her expected profit margin is 66.7 percent. Therefore, her break-even point is close to $9,000 in sales revenue per month ($6,000 ÷ 0.667).
In other words, Mary must make $9,000 each month just to pay her fixed costs and her direct (product) costs. This number does not include any profit, or even a salary for Mary. Since Mary's break-even point is $9,000 a month and she has only estimated making $7,500 a month, she realizes that her business won't survive unless she makes some changes.
If You Can't Break Even
If your break-even point is higher than your expected revenues, you'll need to decide whether certain aspects of your plan can be changed to create an achievable break-even point. For instance, perhaps you can:
- Find a less expensive source of supplies
- Do without an employee
- Save rent by working out of your home, or
- Sell your product or service at a higher price.
Example: After Mary reviewed her break-even analysis, she decided to reduce her expenses by working from home rather than paying rent for a design studio. This will reduce Mary's fixed expenses from $6,000 a month to $1,500 a month. With these savings, her break-even point is now approximately $2,250 a month ($1,500 ÷ .667). Since Mary believes she can easily sell 25 dresses for $300 a piece each month, her total sales revenue will be $7,500 a month. Now Mary will make more than $5,000 in profit each month.
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