How much revenue does your business need to make before you can start making a profit?
Without knowing this, every start-up business owner will struggle to plan cash flow and project other needs of the business adequately for the future.
Break-even analysis is simply where the revenues earned are equal to the company’s costs. At this point, there is neither a profit or a loss.
To perform a break-even analysis for ecommerce businesses, you first need to be clear on the relevant terms and the factors involved in the calculation…
Key terms in break-even analysis
- Fixed costs
These are the costs faced by your business, regardless of the amount of products or services you sell. Sometimes called ‘overheads’, they include utilities, employee salaries, rent, insurance, and other expenses.
- Variable costs
These are the incurred costs based on your product sales. When you sell a product or service, there are costs involved in provisioning labour and materials, payment processing, and other elements of product/service delivery.
- Average price
This pertains to the starting price you would like to set for your products or services.
- Contribution margin
This is the value after subtracting the variable costs from the average selling price.
The break-even analysis formula
Now that we know the relevant terms, we can now understand the break-even point analysis formula, which is as follows:
Fixed Costs / (Average Price – Variable Costs) = Break-Even Point
Let’s say that you own an e-commerce retail business.
The price of the garment you sell is $60, your total fixed costs are $6,000 per month, and the variable costs are $30 per product.
Punching these numbers into the above formula, we get:
$6,000/$30 = 200
This tells us that, after selling 200 products/units, all fixed costs will be covered and your company will have $0 net profit or loss.
Do your own break-even analysis for your ecommerce business
As you can see, a break-even analysis is not as complicated as it may first seem. Now you know the formula, simply follow the above example and calculate your break-even point.
There are various break-even analysis templates you can download online for free. These provide a quick and convenient way to do your calculations.
Make sure you remove any non-cash charges, such as depreciation, when you are calculating your fixed costs – but add back anticipated capital expenditures if needed.
Whether you’re starting a new ecommerce venture or thinking of making changes to your existing ecommerce business, a break-even analysis will help you understand the areas you need to focus on. It may also help you identify areas where you can lower fixed costs and make appropriate decisions as you work towards making your business profitable.
Contact us if you need any assistance with this or any aspect of your ecommerce business finances.