When you start a trade business, one of your priorities will be to make enough money to break even. Yes, you have to spend money to make money, but this can be a risky way to do business if you don’t know what your break-even point is.
The break-even point is marked by the number of jobs you need to complete to cover your operating costs. Once you’ve reached your break-even point, you’re no longer losing money and your trade business is officially turning a profit. It’s an essential part of any trade business plan.
The most effective way to calculate your break-even point is by doing a break-even analysis. This looks at your fixed and variable costs and how changes to these costs affect your profit. It will tell you whether you need to look at changing the cost of your services so that you can make a profit, or at least break even. It’s a crucial calculation for any trade business owner as it will help inform many decisions that support business growth.
Follow this clear and easy how-to guide to calculate your break-even point.
Why a break-even analysis is so important
Calculating your break-even point is a fairly simple calculation – but it’s something that many business owners fail to do. When done correctly, it can be used to:
- Price smarter. Several factors go into figuring out how much you charge for each of your services, including your billable hourly rate. Finding your break-even point will help make sure you’re charging enough to make a profit.
- Manage financial risk. Whether it’s a not-so-good business decision or a slow month of work, doing a break-even analysis will help you avoid the financial risk that could put your business in the red.
- Cover fixed and variable costs. Some of your expenses will move up and down depending on the labour and materials required. These are variable costs. But some expenses will stay the same no matter how many jobs you take on. These are your fixed costs – the background expenses that business owners tend to forget.
- Make informed business decisions. Need to invest in a new work vehicle or piece of equipment? It’ll be easier to make those types of decisions with useful data like your break-even point in front of you.
Set revenue targets. Knowing exactly how much you need to earn to run a profitable trade business will help you set clear financial goals - and estimate a realistic sales forecast.
The formula for breaking even
Here’s how to calculate your break-even point:
Fixed costs / (Average sale price – Variable costs)
= Break-even point
Your break-even point is equal to your fixed costs, divided by your average sale price, minus variable costs. The second part of this equation (average price – variable costs) is also known as the contribution margin. This number tells you how much cash you have leftover to go towards your fixed costs.
To break this calculation down further:
- Gather your data - Make a list of every single expense you pay to run your trade business – including the cost of materials and labour, petrol, equipment, system fees, insurance and marketing costs.
- Identify your fixed costs - These are costs that stay the same and are ongoing – regardless of how much you earn (generally, most of these expenses run monthly). Add these costs together. It can be a good idea to add a 5-10% buffer here to cover any unforeseen expenses.
- Identify your variable costs - These are costs that can vary based on the number of jobs you win, for example, materials and labour (if you pay another contractor for time worked). Adding these sums together can be a little trickier. Try tracking your variable expenses over a quarter and calculate an average monthly cost.
- Decide on an average price - This will depend on your pricing structure. If you have fixed rates for different jobs, you can calculate an average price. Alternatively, you might take an average value of the number of hours you work per week.
- It’s time to do the math - Now, all that’s left to do is plug in the numbers. The sum of the equation is how much money you need to make before you start earning a profit.
Here’s an example:
- Fixed operating costs: $5,000 per month
- Variable expenses: $1,500 per month
- Average price: $2,500 per job
- $5,000 / ($2,500-$1,500) = 5 jobs per month
Make adjustments where required
To improve your profitability, you might decide to reduce your expenses, increase your rates or offer add-on services. See what happens if you adjust some of the numbers in the equation. What makes you more or less profitable?
Things to keep in mind when doing a break-even analysis.
A break-even analysis is a great tool for trade business owners and it plays an important role in how you make decisions, but it isn’t fool-proof.
- Multiple services with multiple prices. Many tradespeople don’t have an ‘average price’ – the cost of a job depends on labour and materials. You might need to work with one job at a time – and calculate a break-even price for each type of job.
- When prices fluctuate, so do costs. This model assumes that only one thing changes at a time. Instead, if you lower your prices but win more work, your variable costs might change because you’re able to work more efficiently with another employee. Ultimately, it’s only an estimate.
- Demand isn’t stable. A break-even analysis won’t tell you what your sales are going to be, only how much work you need to win to run a trade business that doesn’t cost you money. Any adjustments you make in your prices will in some way affect demand.
- Ignoring time and competitors. It’s not unusual for your work to fluctuate seasonally or for changes in the market to affect your pricing and sales. A break-even analysis will give you a good understanding of what your baseline is but will need to be used in conjunction with good cash flow management and sales forecasting.
- Don’t forget expenses. Your break-even result will only be as good as your data. That means accurate expenses are crucial for a reliable break-even analysis.
Measuring your margin of safety
Think of a break-even analysis as a safety net. It tells you how many jobs you must win to cover the fixed and variable costs of running a successful trade business. To ensure you’re always making business decisions based on the most accurate information, update your break-even analysis regularly. It is only an estimate, but for new trade businesses, it’s a great way to gauge when you might be able to break even – and turn a profit.