Break-Even Analysis

A study of the revenue and costs associated with a project or business to determine the point where the inflows exactly equal the outflows.

Harry and Sally have been living together in Sally’s house, for nearly a year. During this time, Harry has been contributing $700/month towards the mortgage, groceries, etc. With their anniversary approaching, Sally performed a break-even analysis and determined that the incremental food for Harry, earplugs needed to drown out his snoring, and additional TV so that she could watch something other than sports...cost an average of $900 per month. So, on their anniversary, Sally is going to break-up with Harry.

Okay, that's a break-up. Where and how do you…break even?

Like...at what volume of your product can you pay your rent, insurance, overhead, salary, and have juuuust enough left over to pay the interest on the loan grandmama gave you to start this embalming company?

So yeah… that's what you do. You’re an embalmer. For a thousand bucks, you stick bodies on this old sewing machine-like thing, wrap tape around them, dip them into magic fluid, and boom...they’re ready to be put on display.

A customer buying the basic package pays you a grand. Sometimes it’s walk-in business. Sometimes it's families with, uh...you know...wheel-in business. And other times, you’re just an upgrade to a funeral package. Thanks and a big shout-out to Bob’s Holy Roller House of Heaven and Furniture Shop. Life-savers.

You outsource most of the work piecemeal to Lucretia. She charges you 200 bucks for a full wrap, old school. The masking tape costs another 80 bucks. And the secret sau...er…Magic Afterlife Fluid Elixir of blah blah blah…or whatever you’re calling it in this week’s special...a gallon of that stuff costs 100 bucks.

So that’s your marginal world. You charge a grand for costs of $200 for labor, $80 for the masking tape, and $100 for the…goop. And that’s it. $380 in costs. $620 in contribution per unit, or unit sale.

The only problem? You have to refrigerate the clients…sometimes for a long time, until you can all schedule the afterlife party. And there’s always a relative stuck in some meeting, or on a trip or a something. So you spend 5 grand a month on rent, and then another 2 grand on electricity and maintenance, and all the other storage things. And yeah, it's kind of nice to not have to carry life insurance...

Anyway…you basically have 7 grand to make up in volume every month to just break even from your operations. So...how many customers do you need?

Well, each customer contributes 620 bucks so...thinking aloud…if you had 10 of them, that’d contribute $6,200, and that’d get you close, right? To get the actual number, just divide 7,000 by 620 (the revenues by the unit contribution to profits), and you get 11.2.

So really, you need a dozen customers a month to break even on this plan. And that leaves a little bit extra for, uh…accidents or whatever. Although, like…what worse could happen, right?

So…the elixir has a formula, and it's not just mayo, ketchup, and a dash of worcestershire. It’s way more than that. But this calculation has a formula, too. There are a few of them, in fact. And for context, you’re thinking about opening a chain of these places all around the country.

You get cheaper prices on tape and Elixir at volume. And maybe you find someone needing less maintenance than Lucretia...for less than 200 bucks per. Anyway…you can find the break even on volume here, right?

You need 12 bodies at a grand each, or 12 grand total, to get there. To calculate, you took your fixed recurring costs of the 5 grand in rent and 2 grand in electric and other bills...7 grand total...and divided it by the unit contribution of 620... and that’s how you got the 11.2. And you round up a body, because, well, of course you can’t have a fraction of a body. Not without ticking off some customers, anyway.

The formula: Break even volume in units = fixed recurring costs over unit contribution.

Or, if you only had the contribution margin, i.e. the profit margin of your unit sale, you could get the answer as well. That is…the contribution margin here is 620 over a thou, or 62%. So to get the break even volume you need on a sales dollars basis, you just divide that 7 grand figure...your fixed recurring overhead...by the contribution margin figure and...voila. You get the same number.

So...about that loan from Grandmama you used to start this thing. Well, she’s off to a better place now, but you still have to pay off that loan, and you want to make enough profit so that you can go build another 100 of these stores and really make something of this life. Or the next. Either is fine. But you need to get started. Before you run out of time…

You've set a target profit number for this store for the months going forward of 4 grand. Big “up” numbers. But you also got a lot of free press from the, uh…rat incident. So you’re expecting a lot of customers coming in, and you already have a load of reservations. And you’re optimistic about your new partnerships with the U.S. Hang Gliding Association, the Grand Canyon Motorcycle Jumping Association, and The Harnessless Climbers Association.

So your target is 4 grand a month in profit. How do you get there? Well, you can think of a need for profit almost like it’s just more...overhead. Today you have 5 grand in rent and 2 grand in utilities and everything else for 7 grand. You’ve been thinking of yourself as an absentee owner, and haven’t been taking a salary. And you should. Some day. But for now, what Grandmama left you is...covering things.

Anyway…that’s 7 grand in fixed recurring overhead. Then you want 4 grand a month in profit. So think of your top line here as being 11 grand.

What’s your target volume then? Like...at a grand a pop (or mom or uncle or aunt…), how many sales do you need in a month to hit your target profit of 4k?

Well, that’s 11,000 divided by the 620 of contribution…and that gets you 17.7...call it 18 bodies a month. Not that bad a goal. That’s like almost 1 a day.

And your target sales volume? Take the 11 grand, divide it by the contribution margin of point 62...and you have that 17.7k. Same calculation, more or less…just flipping around a few numbers.

So where do things get ugly here? Or...well, uglier? What if you could raise prices with no diminishing of volumes? Like...could you charge 1,500 or 2 grand for eternal life…likeness? Or...what if it went the other way? How sensitive is your pricing? Or said in a very macro/micro econ way, how steep is your demand curve?

Ok, here’s another thought. What if your costs went down with scale? Like…if you had 10 shops, could you get masking tape at half the price you’re paying? Would labor go up or down? Is Lucretia a kind of one-time gift...or is she making way more than what market prices are for what you’d have to pay in the future to get more embalmers?

If you make more money, the bigger you get, that’d be called operating leverage. That is…you’d have it.

Anyway, so much to think about. So little...eh, actually, maybe you have tons of time to think about it...