Lesson – Break-even Analysis

In order to estimate the initial optimal volume of production you should find the balance between available resources, capacity, costs of production and the estimated revenue. This process is called a Break-even Analysis.

Once you have an estimate of the unit cost of producing your product/service, and the number of units you think you can sell in a given period (usually one year), you can use the financial information you will have gathered during the market research, to work out what the breakeven point will be.

The breakeven point is the point of sales that bring in enough income to pay for the total cost of running the enterprise; beyond the breakeven point you will start to make a profit. A basic calculation for a given period ― at least 2 years are suggested ― is the following:

Just keep in mind that this breakeven analysis is for you to play around with. Experiment with different unit costs, different amounts sold and different prices you can sell at. It is a way of thinking about how to arrange your finance and if the idea is financially viable.

Remember, it will take some time to generate the volume of sales necessary to reach the breakeven point. This is normal and that is why raising finance to cover the short-term deficit is often essential to get the enterprise off the ground. Short-term deficits are mostly visible in the Cashflow ― more on that later ― and the Profit and Loss Account which is usually assembled annually.