Finance Terms Every Entrepreneur Should Know
“At what point I am going to make a profit?” is the ultimate question that every entrepreneur asks themselves. The answer is: after at your breakeven point.
In economic terms, this is describes at the point at which your total cost and total revenue are equal: there is no net loss or gain. All costs are paid by the company at this point but, the company has zero profit.
Breakeven analysis, which looks into this relationship between costs and sales revenue, is a very important part of any business, but especially for startups, it is crucial. Just after you establish your business, you can determine the ideal price of your products, the number of units that you need to produce and you can forecast how many months you won’t be able to make any profit. And knowing exactly when you will start to make money will help you plan how much initial investment you need!
Let’s break down the break-even point:
The essential concepts to understand for calculating your break-even point are costs, revenue and price.
Fixed Cost: Fixed costs are the costs that are independent of the amount of goods or services produced by the business. For example rent, or salaries. For fixed costs, you have to pay them even if you do nothing for the month.
Variable Cost: A variable cost can vary in relation to the amount of business activities. For example raw material, energy usage, labour, logistics, etc. The more you produce, the more you spend: if you can relate to this, then it is a variable cost.
Total Cost: Your total cost equals your fixed costs and the variable costs.
Costs have the biggest influence on your breakeven point, since your sales price of each unit is generally the same. So, what happens when your landlord increases your rent prices? You can read more about the effects of changing a variable on breakeven analysis here.
A great starting point for your analysis is a simple graph of your revenue and costs, as you can see from the graph, breakeven point is where your revenue just exceeds total costs. At this point, your profit is 0. It is after this point that your business will begin to make a profit, provided your estimations of your cost and revenue remain the same.
For more information about how to find your startup’s break-even point, here’s a great template for you to evaluate your business!