A break-even analysis is a key part of any good business plan. It can also be helpful even before you decide to write a business plan, when you’re trying to figure out if an idea is worth pursuing. Long after your company is up and running, it can remain helpful as a way to figure out the best pricing structure for your products.
Basically, a break-even analysis lets you know how many units of stuff—say, how many ham sandwiches, iPhone apps, or hours of consulting services—you must sell in order to cover your costs.
You’ll need several basic pieces of information:
• Fixed costs per month
• Variable costs per unit
• Average price per unit
Once you’ve got your cost data and a target price, plug them in to this formula:
BEQ = Fixed costs / (Average price per unit – average cost per unit)
This will tell you your break-even quantity (BEQ), the number of units you need to sell to cover your costs. Any sales above that are pure profit. Anything below means you’re losing money.
Here’s an example. Suppose you’re turning a jewelry-making hobby into a business. You have $1,000 per month of fixed costs (studio rent, utilities, equipment, etc.). Your variable costs for each necklace are $50 for materials and labor. You’d like to charge $70 per necklace, since that’s what similar pieces are selling for.
BEQ = $1000 / ($70 – $50) = $1000 / $20 = 50
That means you’d need to sell 50 necklaces a month at $70 each in order to break even.
Break-even Cannibalization Rate (BECR):
Now that you understood about break even analysis, let us get to a concept of break even cannibalization. Often, when we launch a new product in the market, some of the sales of the new product could also come at the cost of the sales of our own old product. This is called Cannibalization. It is simply the percentage sales of the new product that come from the old product.
Companies want to understand what is the maximum that they can allow for its new product to cannibalize its old product. Is it fine if my new product eats away 10% of my old product sales. The answer to it is: the maximum cannibalization rate that companies can allow is the BECR.
BECR is the cannibalization rate at which the losses incurred by the company due to loss of old product sales is equal to the gains made by the company due to the new product sales. If the cannibalization rate goes beyond the BECR, the company will incur losses and, similarly, if the cannibalization rate is less than BECR, the company will make profits.
Break-even cannibalization rate (BECR) = (Unit Contribution of the new product)/(Unit Contribution of the old product)
Hope this is useful, thank you!
Parts of this article is directly lifted from http://www.inc.com/guides/2010/12/how-to-perform-a-break-even-analysis.html and http://home.ubalt.edu/ntsbarsh/business-stat/otherapplets/breakeven.htm