One of the key reasons why e-commerce businesses fail to grow is the lack of understanding surrounding break-even points and break-even analyses. Doing a break-even analysis is a key part of your accounting and finances. Once you know your break-even point, you can better map out the strategies that can help you surpass it and make a profit.
In this article, we’ll go through everything you need to know about the break-even point and how to do a break-even analysis. After that, we highlight a few strategies that e-commerce businesses can use to lower their break-even point. Finally, we’ll explain the limitations and how the break-even point only makes up one piece of the puzzle.
- What is a break-even point and break-even analysis?
- Why should e-commerce businesses do a break-even analysis?
- How do you do a break-even analysis?
- How can you lower your break-even point?
- What are the limitations of a break-even analysis?
- Key takeaways on break-even points for e-commerce
What is a break-even point and break-even analysis?
The break-even point is the point where your revenue equals its costs, meaning there is no loss or profit. If your business has reached the break-even point, your sales are covering both your fixed and variable costs. Hence, it will change in accordance with any changes to your variable costs. The break-even point can be calculated for a specific product as well.
Doing a break-even analysis for your e-commerce business involves calculating the point where profit equals zero. You can do this based on an average, on units or on revenue. It typically makes more sense to base the calculations on units if you’re doing the break-even point for a single product or if your business only sells one product.
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Why should e-commerce businesses do a break-even analysis?
The first of many benefits of performing a break-even analysis is how it helps with defining the pricing strategy for your e-commerce business. Though you might choose to do market-based, value-based or other forms of pricing, it’s always important to make sure the prices you’ve selected are high enough. The break-even point allows you to set clearer pricing goals.
You can do a break-even analysis even before you’ve decided to stock a certain product or take on a certain opportunity. This way, you can better gauge whether any risk involved is worthwhile. For example, if there’s a trendy item you’re looking to stock, but you find you’d have to price it above what customers would be willing to pay to break even, you can decide against stocking it.
The last key reason e-commerce businesses should perform a break-even analysis is it allows you to gain a better understanding of all your costs. Not only is this an important part of a business plan anyway, it means you’ll catch any expenses you might have otherwise forgotten and avoid surprises later down the line.
How do you do a break-even analysis?
Before we can do a break-even analysis, we need to first know what your fixed costs and variable costs are. Your fixed costs are those you must pay regularly and remain the same (or roughly the same) such as rent, insurance and utilities. Variable costs are those involved with making a sale such as for the wholesale product, shipping and marketing.
As mentioned above, you can perform a break-even analysis based on an average, on units or on revenue. The first and most basic way gives you the average number of units to sell. This formula will give you a general idea of how many units you have to sell in order to break-even based on the average price of your products.
Break-Even Point = Fixed Costs / (Average Price – Variable Costs)
Next, you can calculate the break-even point that gives you the number of units to sell in order to break even. The formula gives you the exact number of units you need to sell of a single product to cover all fixed costs and variable costs for that product. This tends to make more sense if your business only sells one product or if all products are the same price.
Break-Even Point (Units) = Fixed Costs / (Revenue Per Unit – Variable Costs Per Unit)
Last but definitely not least, you can calculate your break-even point to give you how much sales revenue you need to make to break even. This is based on the contribution margin or (Sales Revenue – Variable Cost) / Sales Revenue. Hence, it works well if you have one product or if all have the same contribution margin. You can use an average as well.
Break-Even Point (Sales Revenue) = Fixed Costs / Contribution Margin
How can you lower your break-even point?
The easiest way to lower your break-even point in an e-commerce business is to raise product prices. However, this isn’t always the best option if you’re trying to remain competitive or you know your customers will be sensitive to price changes. Hence, it can be better to lower your fixed and/or variable costs.
To lower your fixed costs, go through your break-even analysis and determine where you can lower expenses or remove expenses entirely. Some costs will be easier to identify. For instance, finding a cheaper electricity provider or warehouse. Others might involve more work. For example, seeing out if you can swap a software subscription without giving up key features.
In terms of variable costs, this typically becomes easier to lower when you have economies of scale on your side. Negotiating with existing or potential suppliers becomes significantly easier. The same goes for boxes, packing peanuts, wrapping paper or other similar items that are usually cheaper in bulk.
However, there are some ways to decrease variable costs even if you’re not selling large volumes. For example, looking into shipping software that can help lower shipping costs on every order or testing different marketing avenues to see if you can improve your return on investment.
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What are the limitations of a break-even analysis?
Though doing break-even analyses regularly is important for e-commerce businesses, there are limitations to how much it can tell you. First of all, the break-even point is really only one, basic benchmark. With most businesses selling multiple products and different price points, it’s hard to figure out exactly how to price every single product. Plus, variable costs can fluctuate a lot.
Furthermore, there are many factors that the break-even point can’t take into account. For example, if you’re basing product pricing on the break-even point alone, you’ll ignore competitor pricing and value-based pricing. Plus, it can be hard to perform a break-even analysis for the future when there might be changes in costs due to seasonality or other reasons.
Key takeaways on break-even points for e-commerce
Ultimately, the steps you need to take when performing a break-even analysis aren’t too complicated. You should always keep the break-even point in mind when assessing your e-commerce business’s profits. Though the break-even analysis has limitations, it can act as the foundation for many other key factors and shouldn’t be ignored.