Early in the startup process, it is important for founders to consider the financial needs of the potential business and complete a break-even analysis. After determining a customer problem that will be solved by a new business enterprise and determining how to create and deliver that solution through a new product or a new service, a founder should make sure delivery of that solution will not only cover operating costs but also deliver a profit. If break-even and a profit cannot be achieved, then the enterprise, product or service should not be pursued.
This blog post will describe best practices to make that analysis as real and as useful as possible. Here we will consider the information that might be included in such an analysis to assure a thorough review that will support good decision making.
First, choose a period for this analysis. We suggest making a monthly forecast. Operating costs and sales revenues are sometimes easier to forecast on a monthly basis. Remember to account for any seasonal adjustments in expenses or sales if applicable to your product or service, as this might make a big difference on an annual basis. This can be done by using the average of what is expected monthly.
Second, identify and list expenses that will be incurred to create and deliver the proposed solution (product or service). This listing might include expenses related to producing, packaging, marketing, selling, transporting, and shipping a product or service. The salary or wages of management and employees can also be included. For startup founders who are dependent on income from the business to cover living expenses, we recommend that the founder’s living expenses also be added into this analysis, as shown in Fig. 1. Your list might be more comprehensive and detailed than this one.
Next, establish a unit price based on the unique value proposition of the business. The best price is the highest price that a customer will pay. As described in our previous post on how the UVP influences price, the value of a product/service will be determined by that product/service’s quality, how well it solves the customer problem and how it compares in the marketplace. The more relevant, valuable, and unique a product/service is, the higher the price the market will bear. Other factors influencing price are market conditions and competitor products or services.
After collecting these underlying numbers – expenses and price – it is time to put them together in a break-even analysis. Calculate gross margin per unit by subtracting total costs of producing and selling a unit of product or service from the selling price per unit (see Fig. 2). As Fig. 2 shows, small changes in the selling price or unit cost of your product or service can have a big impact on the number of sales required to reach your target gross margin.
Lastly, consider any price adjustments or sales offsets such as discounts, credit card or delivery charges per unit. Figure 3 illustrates the impact of accepting credit card payments and covering delivery (or shipping) costs on the number of sales required to achieve total gross margin.
Many thanks to John Galati, NaperLaunch Coach and SCORE Volunteer, for preparing the spreadsheets used in this post. For more in-depth discussion on this and related topics, consider registering for the NaperLaunch Academy workshops. NaperLaunch coaches and SCORE mentors are also available to provide one-on-one virtual assistance.