It’s quite obvious that it’s really important to test the profitability of a business model for any business, and especially for a startup building a new business.
But how to test the profitability of your business ?
To test the profitability of a business model, you need to calculate the break-even point yearly in your financial forecast.
Ok, but what is a “break-even point” ?
The break-even point is a financial term that refers to the amount of revenues where a business doesn’t make either profit or loss. Thus, if your revenues are below this break-even point then you will lose money. On the contrary, if you make more revenues, you will be profitable. That’s why it’s called a “break-even point”.
And, how do I calculate the break-even point?
Basically, the break-even point is when your revenues are equals to your costs. They cancel each other out.
Revenues – costs = 0
So, if you know your forecasted costs, you will be able to calculate your break-even point (the minimum revenues you need to make to be profitable).
However, it’s a bit more difficult to calculate than it looks like at first sight… Indeed, there are to 2 kinds of costs in any business : fixed costs and variable costs.
The fixed costs are the costs of your business that doesn’t vary depending on revenues. Whatever your revenues are, your fixed costs remain the same.
The variable costs depend on revenues. They are generated proportionally to revenues. Variable costs can be subtracted from revenues to get margins.
Margins = Revenues – variable costs
Thus, the break-even point calculation can be simplified : you can calculate the break-even point by replacing “revenues” with “margins” (also called “gross profit”) and “costs” with “fixed costs”.
Break-even can be then calculated with this formula :
Margins – fixed costs = 0
So, the break-even point is when your margins are equals to your fixed costs.
How should I then analyse my break-even point ?
What is really interesting in calculating the break-even point is to calculate the targeted amount of products/services to sell to get necessary margins to reach the profitable threshold. Indeed, you would then be able to know the necessary volume of goods to sell to get profitable with a defined level of fixed ressources (fixed costs).
“Targeted volume of goods to sell” = “Targeted magins to reach break-even” / “Margin by unit sold”
It’s really interesting for you, because you are then able to analyse the reliability of your balance between ressources and revenues forecasted. You can thus analyse if ressources you have forecasted are sufficients to reach a target amount of good to sell to be profitable.
It’s an important analysis, because the break-even point is not a fix point. Indeed, it depends directly on your fixed costs (ie, ressources you forecasted). The break-even point can evolve year over year. It’s then important to understand that the more you forecast ressources the more revenues you will need to make to reach the break-even point (and thus profitability).
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