Breaking even is top of mind for many retailers grappling with the businesseffects of COVID-19.

So it’s good to get a grasp on what breaking even means, how to calculate it,and some actionable steps that retailers and finance teams can take toactually break even.

Doing a break-even analysis can also help inform those tough decisions aboutany stores to open, reopen or even close. Here’s what we’ll cover:

Let’s get started!

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What is a break-even analysis?

“A break-even analysis calculates how much income you need to cover yourexpenses,” explains Rob Stephens (CPA), founder of CFO Perspective. “Break-even analysis provides a reality check for any investment you make in yourbusiness. These investments might be a new product or location.”

Retailers have to make many guesses when deciding whether to add a productline or open a location. But retailers rarely know how much new product theywill sell or what sales will be at a new location. Thankfully, estimates ofexpenses are often more accurate than sales estimates.

Think expenses, not sales

In 2020, it has become much more difficult to put a reliable forecast onsales, with COVID-19 shifting consumer behavior in new ways each week andmonth. Put simply, people are buying differently.

“I’ve built many projections,” says Rob. “When I ask someone how much they’llsell, they usually answer, ‘I don’t know’. That’s very true, but it’s notuseful for making a decision.

“Break-even analysis simplifies the question, by figuring out the least salesneeded to cover your expenses. It’s much easier to answer whether you canexceed the sales needed to break even, than it is to guess your future sales,”says Rob.

Why is a break-even analysis useful for retailers?

“A break-even analysis is most useful for a new product or changing the priceof an existing product,” explains Rob. “For example, how many more units wouldyou need to sell with no decrease in total profit if you cut your price by 10percent?”

Break-even analyses are also important for managing financial risk, as BrianCairns, CEO of ProStrategix Consulting, explains.

“Your financial risk goes up the closer you are to your break-even point. Ifyou are less than 10 percent above your break-even point, then it would onlytake a minor increase in costs to fall below. If you are around 30-40 percentabove break even, then you have a lot more room to maneuver.”

Three times retailers might do a break-even analysis

Break-even analyses are helpful when setting your price or evaluating a fixedcost change, or purchase equipment. Break-even analyses can also help assessyour commercial rent or hiring needs. And they are also useful when you are:

  • Starting a business: Performing a break-even analysis can be challenging when starting up, because you don’t yet have a track record of business data. Still, doing a break-even analysis (using industry or public competitor data) can help inform financial planning.
  • Launching a new product: A break-even analysis can help you figure out how to price a new product and what impact that price may have on other products in your line.
  • Exploring new sales channels: A break-even analysis can also help recalculate changed expenses, especially given many retail businesses are now pivoting to a greater focus on online selling.

Break-even analysis formulas for retailers

Now to the math.

“The formula is very simple,” explains Rob. “Break even sales equal yourexpenses. Calculating it is a little trickier because you have expenses thatvary with your sales (i.e., variable costs) and expenses that don’t, such asfixed costs.”

Here are the commonly used formulas for doing a break-even analysis. The firstis based on units, the second on sales dollars.

Here is a quick breakdown of some of the key components in these formulas.

Fixed costs

“Fixed costs are costs that don’t change whether you sell one unit or onethousand units. For example, if you’re opening a new location, then the costof the building is a fixed cost,” says Rob. Other fixed costs include:

  • salaries
  • utility bills
  • loan repayments
  • equipment hire
  • lawyers
  • accountants
  • and other advisory services.

Variable costs

Variable costs are those that change across different parts of the businessyear. For example, a retail business might spend more on promotionaladvertising and casual staffing in the weeks leading up to Black Friday – thepoint in the year where many retailers aim to break even.

Contribution margin

Investopedia explains the contribution margin as the difference between thesale price of a product and the variable costs associated with its productionand sales process. As a simple formula, it looks like this:

The limitations of a break-even analysis

But break-even analyses have their drawbacks.

“It can be difficult to estimate marginal costs accurately. For example,utilities can be variable, but how do you appropriately allocate utility useto a given unit? It’s very difficult,” says Brian.

“Therefore, many people use an average across the year, and while that can bea good proxy, it breaks down if you have any significant seasonality. This iswhy a break-even analysis is helpful for knowing, directionally, where youshould be. It’s always wise to err on the side of being significantly aboveyour break-even point.”

Product variety

“Break-even analysis isn’t as effective when analyzing a mix of products,”adds Rob. “The break-even sales amounts vary, with the variance in the marginsbetween the products.

“The simple break-even formula assumes your sales price and costs remainstable. In real life, your variable costs change as the amount of unitschanges. For example, you may get a volume discount with larger inventorypurchases.”

Price cannibalization

“The biggest mistake I see people make with break-even analysis is ignoringcannibalization,” says Rob. This is when one product decreases sales ofanother product. For example, selling a new model will greatly reduce thesales of the old model. Think of the iPhone, for example.

“Price cannibalization is reducing your price to existing customers instead ofselling to them at your old price, says Rob. “Let’s say you usually sell yourproduct at $100, but you lower the price to $90 to drive growth. If younormally sell 1,000 units, your profit dropped $10,000 — ($100-$90=$10 X1,000) — which has to be covered by the profits from selling more units at thereduced price.”

How to lower your break-even point

There are two ways to lower the break-even cost: either lower your fixed costsor increase your margin. “The most effective way to reduce the sales you needto break even is to reduce your fixed costs. For example, you can rent a newlocation instead of buying it,” says Rob.

To lower break-even points, retailers can also:

  • Increase the prices of the goods
  • Talk to landlords about lowering rents
  • Or work out lease terms linked to sales volumes
  • Reassess opening hours and cap employee shifts
  • Reduce your fixed costs, by converting them into variable costs.
  • For example, buy smaller quantities, to reduce the fixed cost of a large initial order. from World Pet Association

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