Are you wondering when you’ll start making money from your retail business? The first step is understanding your break-even point. Doing a break-even analysis will help you determine how much you need to sell to cover your business expenses and eventually make a profit.
Read on to learn about the variables involved in running a break-even analysis, how to calculate your break-even point, and strategies to decrease your break-even point.
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What is a break-even point?
A break-even point (BEP) in retail is when your product sales are equal to your business expenses. There is no profit and no loss at the break-even point. To do a break-even analysis you’ll need to look at the following components:
- Fixed costs. These are the costs you incur to run your business. Fixed costs don’t fluctuate based on the number of units sold. For example, rent for your brick-and-mortar location, your POS system and ecommerce website subscription, and payroll are all fixed costs.
- Variable costs. These are the costs to manufacture or buy the products you sell. Variable costs change depending on how much you sell. For example, if you’re selling more inventory, you’re spending more on variable costs to make or buy the extra stock.
- Sales price of each product. These are the retail prices you set for each of the products you sell.
- Contribution margin. This is calculated by subtracting variable costs from the sales price to determine how much money you have left to pay your fixed costs. It helps you measure if product sales are generating enough revenue to cover fixed costs and if you’re profiting.
- Profit and loss. Profit is the amount of money your business earns after you’ve surpassed the break-even point. If you don’t reach the break-even point in your business it means your sales volume is less than your business expenses and you’re operating at a loss.
How to calculate your break-even point
To determine at exactly what point your retail sales will cover your expenses you can do a break-even analysis using the following formula:
Break even point = fixed costs / (sales price per unit - variable costs per unit)
The break even point is determined by dividing the total fixed costs by the difference between the sales price per unit and variable costs per unit. Your total fixed costs include all the expenses to run your business.
Determining the contribution margin
Calculating your contribution margin will help you understand if your product pricing strategy will cover your fixed costs and lead to profitability. Let’s look at how it’s calculated:
Contribution margin = (sales price per unit - variable costs per unit) / sales price per unit
Examples of break-even point analysis
It’s possible to calculate your break-even point in units or sales dollars. Here, we’ll look at both examples:
Break-even point analysis in units
Let’s start by calculating the break even point in units for one month:
- Your fixed costs are $5,000 per month including rent, sales staff, and your point-of-sale (POS).
- You sell women’s jeans and the variable costs to manufacture one unit (or buy one unit at wholesale) is $10, including materials, labor, and shipping.
- You set the retail price at $35 each for a pair of jeans.
Now we can calculate the break-even point using the formula we provided:
Break even point in units = $5,000 / ($35 - $10) = 200 units per month
Based on this calculation, you’ll need to produce or buy and sell 200 pairs of jeans to cover your total fixed and variable costs. If you sell 200 units, you’ll break even. If you sell more, you’ll start to profit, and if you sell less you’ll experience a loss.
Break-even point analysis in dollars
Let’s use the same scenario to calculate the break-even point in dollars for one month.
Here’s the formula:
Break even point in dollars = fixed costs / contribution margin
See the formula above to calculate your contribution margin.
So, using the same numbers from the example above we’ll find the break even point in dollars.
Break even point in dollars = $5,000 / ([$35 - $10] / $35)
- Calculate your contribution margin.
($35 - $10) / $35 = 0.7143
- Divide your fixed costs by your contribution margin.
$5,000 / 0.7143 = $7,000 ($6,999.86, rounded to the nearest dollar)
This calculation confirms you need to sell $7,000 worth of jeans in one month to break even. Anything you sell after this amount is considered profit.
To check this calculation, use the 200 units from the break-even analysis and multiply it by $35 (sales price per unit) to get $7,000.
What causes your BEP to increase or decrease?
Your break-even point can increase or decrease if there are changes in any of the variables used to calculate it.
For example, using the numbers above, if your sales price per unit and variable costs per unit stay the same but your fixed costs increase or decrease, the following will happen:
- Fixed costs increase. Your BEP will also increase because you’ll need to sell more product units to cover your business expenses.
- Fixed costs decrease. Your BEP will also decrease because the number of units you need to sell to cover your fixed costs will go down.
Here’s the math:
Fixed costs increase by $1,000 per month (from $5,000 to $6,000)
Break even point in units = $6,000 / ($35 - $10) = 240 units per month
Now you’ll need to sell 240 units per month instead of 200 to break even.
Fixed costs decrease by $1,000 per month (from $5,000 to $4,000)
Break even point in units = $4,000 / ($35 - $10) = 160 units per month
Now you’ll need to sell 160 units per month instead of 200 to break even.
Cutting costs can help you decrease your BEP and turn a profit
As you’ve learned from the calculation above, if your fixed costs decrease, the number of units you need to sell each month to cover business expenses goes down. But if you continue to sell the same number of units (or more) without reducing your retail prices, you’ll be profiting.
That’s why it’s important to understand where your break-even point is and how you can improve it by reducing your overhead. You can do this by negotiating your rent, reducing your salary for a short time, or looking closely at all of your business expenses and eliminating unnecessary costs such as subscriptions that you don’t use.
How to deal with sales changes that affect your break even point
With any business venture there are risks. If your sales drop due to seasonal downtime or changes in the economy, you may not be able to sell enough product units to reach the break-even point.
To avoid a loss, you can increase the retail prices of your products or determine how to reduce your fixed costs and variable costs. While you have more control over your fixed costs, it doesn’t hurt to negotiate with suppliers to reduce the costs to buy or manufacture the products you sell. Even if it’s just temporarily while you’re experiencing a lull in sales.
Why is finding your break-even point important?
Calculating your break-even point before your store even opens will help you make a plan and understand the risk involved with your new venture.
But if you’re already in business (because sometimes you’ve got to just start), you can use the break-even analysis to better understand where your business stands today, and you can run these calculations before launching a new product to make sure it’s worth it. Will you be able to profit by selling this new product?
The end goal is making money, but finding your break even point is also important for:
Setting revenue goals and targets
By doing a break-even analysis you’ll know how many units you need to sell and how much money you need to make to turn a profit. And knowing this will help keep you motivated and on track.
Making better pricing decisions for new and existing products
Your break-even analysis will show you whether your retail product pricing is too low or if your fixed or variable costs are too high. You’ll want to do competitor research to understand the costs and retail prices for similar products to make sure you’re not setting your prices too high or too low.
LEARN MORE: To learn more about product pricing, read our post Product Pricing: How to Set Prices For Wholesale and Retail that walks through a few of formulas and steps you can take to create successful pricing strategies for your product, whether you sell wholesale, retail, or both.
Creating short- and long-term business plans
By understanding the total number of units you need to sell each month to break even and profit, it’s easier to make a plan and succeed at retail merchandise management. This includes your product assortment, your buying budget, and inventory planning. It can also inform your sales and marketing strategy so you know how aggressive you need to be to sell through your inventory.
For example, if you know you need to sell 200 pairs of jeans per month to break even, you can plan to buy and sell more so you will not only break even but also make money. But if you buy 250–300 pairs of jeans, you’ll need to devise a strategy to sell the units in one month. Otherwise you’ll risk experiencing a loss.
And as your business grows you may also want to open more retail locations or opt for the click and mortar business model. By doing a break-even analysis, you’ll understand how many more pairs of jeans you need to sell to pay the additional fixed costs that come with scaling your business.
Mitigating financial risks
Calculating your break-even point before you start your business or before launching a new product will help you avoid business ideas or products that can lead to a failure.
Planning your finances and securing funding
Knowing how many units you need to make (or buy) and then sell to customers will help you determine what your startup costs will be. If you’re already in business, it will help you understand how much money you need to set aside to operate and grow your brand.
If you’re fundraising for your retail business, a break-even analysis is typically required to prove to investors that your business has potential to mature and make a profit.
Evaluating fixed and variable costs
Finding your break-even point is crucial to understand if your fixed and variable costs need to be evaluated, and perhaps reduced. In some cases you can increase your retail prices, but when this is not an option you’ll need to look at your business costs and try to improve them to break even.
For example, if you need to reduce your variable costs for one unit of jeans from $10 to $8, you may want to source fabric from a different supplier or look for a new cut-and-sew factory. But before you jump ship, it’s best to try and negotiate with your existing suppliers (as long as you’re happy with the quality they provide).
Using break-even analysis for your business
Now that you have a better understanding of what the break-even point is and how to calculate and analyze it, it’s easy to see that the decisions you make about how you’ll operate your business, price your products, and reach your sales goals are linked.
Knowing your break-even point is a key factor in setting retail prices and managing costs so your business can profit.