We continue talking plain English with you in this fun and crazy world of marketing plan financials and move on to the all important Breakeven Analysis. The Breakeven Analysis is especially useful when you’re developing a pricing strategy, either as part of a marketing plan or a business plan. The Breakeven Analysis is actually pretty straightforward and asks one question – when do you break even and turn a profit?
Simple. Not quite but I will explain in plain English.
You mean there is a formula for this thing?
Yes, you knew I would eventually get to a formula, but fear not those math haters out there, it is straightforward. Here is the formula:
Fixed Costs divided by (Revenue per unit – Variable costs per unit)
Fixed Costs – Fixed costs are costs that must be paid whether or not any units are produced. Things like rent and equipment fall into this category. It usually goes on for a certain period of time or over the range of a production cycle. These costs are fixed only over a specified period of time or range of production.
Variable Costs – Variable costs are the things that make it fun and go up and down based on your production levels. Things like materials, labor, overhead are in this category.
Let’s give you a real example:
If your total fixed costs were $500,000, the price tag of your product (unit) was $25, and your variable Costs were $15, the equation would look like this:
500,000/25-15 = 500,000/10 = 50,000
This means you would need to sell 50,000 units to break even. Everything over that is profit and you dancing to the bank.
This is not a perfect equation
Bplans.com points out that this equation, while important, can be misread or misinterpreted. Here are some key things they point out:
- It is frequently mistaken for the payback period, the time it takes to recover an investment. There are variations on break even that make some people think we have it wrong. The one we do use is the most common, the most universally accepted, but not the only one possible.
- It depends on the concept of fixed costs, a hard idea to swallow. Technically, a break-even analysis defines fixed costs as those costs that would continue even if you went broke. Instead, you may want to use your regular running fixed costs, including payroll and normal expenses. This will give you a better insight on financial realities. We call that “burn rate” these post-Internet days.
- It depends on averaging your per-unit variable cost and per-unit revenue over the whole business.
However, whether we like it or not, this equation is a cornerstone of financial analysis. You may choose to leave it out, but really, a business or marketing plan would not be complete without it.
The last part of our Marketing Plan Financials in Plan English sections focuses on Cash Flow Analysis. This part of the marketing plan financials is there to demonstrate how your marketing group/division will maintain a cash positive nature based on budgeting and where you might need cash infusions based on sales projections. As important as when you will break even, you must be able to show how, on a monthly basis, you will manage the cash flow to support the business and not sink it from an overly ambitious strategy and action plan.Google+