Today’s blog is a quick “How To Guide” focused on determining your break-even point. The basics are pretty simple, however, we’ve broken it up into five steps that will help you ensure that you will always come out ahead.
This analysis is a preliminary step in the understanding of financial statements as a tool to better refine equipment rental business practices for maximum profits. It also presents the opportunity to look at operations from a different perspective.
In order to perform a break-even analysis, you’ll need a Profit and Loss Statement. Expenses will need to be reviewed (as defined in Step 1), and cannot be done so without some outline of your expenses. Once you have your P&L printed or in Excel, we’re ready to start.
Take a Profit and Loss Statement and mark each expense as either a variable or fixed cost.
Variable Costs: Costs which may vary based on production or services, or another business variable. Some examples include sales commissions, wages, labor rates and inventory.
Fixed Costs (also known as “Period Costs”): Costs which remain unchanged regardless of the output of production or services. Examples would include rent, utilities, insurance, and loans.
Some expenses can be split between variable and fixed, in cases such as repair and maintenance. As we’re all aware, repairs and maintenance are necessary to have items to rent. And the more rental items you have, the greater your repair and maintenance costs. If ever in doubt, mark it as fixed.
Add up all the variable and fixed costs separately.
NOTE: For illustrative purposes, we will use $4,000 in variable costs, $3,000 in fixed costs, and total sales of $10,000
Divide the total variable costs amount by the total sales to get the Variable Cost percentage. This is the percentage of sales that are used to cover your variable costs. Again, for illustration purposes, we are assuming that our total sales is $10,000.
$Variable / $TotalSales = VariableCost%
e.g.: $4,000 / $10,000 = 40%
Subtract the Variable Cost percentage from 100% (full cost) to get the Contribution Margin percentage. This percentage represents what is left over from total sales after all of your variable costs have been covered.
100% - VariableCost% = ContributionMargin%
e.g.: 100% - 40% = 60%
Finally, divide the total Fixed Cost from Step 2 by the Contribution Margin percentage to get the Break-Even Total Sales requirement.
FixedCost$ / ContributionMargin% = Break Even Total Sales
e.g.: $3,000 / 60% = $5,000
The Variable Cost percentage is how much of each revenue dollar that it takes to make the sale. What’s left is what is used to pay the fixed costs and make some profit.
In our example, we found that our Variable Cost percentage was 40%. This means that $0.40 of each revenue dollar goes to costs associated directly with making the sale. That would leave $0.60 for Fixed Costs. However, if Fixed Costs rise by just $1, it will take $1.67 in new sales to break-even.
$1.00 (Fixed Cost Dollar Amount)/60% (Contribution Margin percentage) = $1.6666
We hope you find this exercise useful in assisting your current rate structure.