Starting a new paid marketing campaign is not an easy task.
There are logistical considerations, financial considerations, audience and duration considerations.
Imagine you’ve decided to start a new Google Ads campaign. You have a vague idea of how much everything is going to cost and you really want to get started.
Before giving the green light to your new campaign, you need to know your future profitability, especially if your profits are balanced with your costs.
Why does that matter?
At this point in the life of your campaign, you are ready to make a profit instead of going into the red.
How do you determine this point?
By doing a breakeven analysis.
What is breakeven analysis?
Whether you’re running a PPC campaign, adding a new advertising stream to your ongoing strategy, setting up an ecommerce store, or even opening a brick and mortar store, you need to do a breakeven analysis.
As mentioned above, it tells you when to anticipate your ambition to pay off.
In addition, this analysis will inform you whether your company is profitable or whether it is impossible to achieve financial success given your business model.
By helping identify fixed costs (costs like rent) and variable costs (like materials), you can set prices that reflect those costs and predict when your business will hit the borderline between cost and profit.
This phase between profit and expense is known as the breakeven point (BEP), the phase in which income equals costs. Once you have identified your BEP, evaluate all of your costs from renting to labor to pricing structure to make sure you are not spending unnecessary money.
First, determine whether your costs are too high or your prices are too low to reach your BEP in a manageable period of time.
Next, decide whether your plan is sustainable.
Not only will your BEP alert you of a specific event that should signal your move out of the red, but it will also let you know if you need to adjust your business spend.
Why should you do a breakeven analysis?
Breakeven analysis is a hallmark of any good business plan. It allows you to determine cost structures and whether you should move forward.
While it looks like a breakeven analysis can only be completed before your business is launched, this process can be helpful well beyond your business launch.
By evaluating and re-evaluating your company’s cost structures, you can forecast different outcomes regardless of where you are in the life of your company.
The advantages of this type of analysis include:
- correct pricing for the product or service
- Point of view of profitability
- provides information on customizing progression strategies
When should you do a breakeven analysis?
A breakeven analysis can be carried out at any time. However, there are four different actions that should trigger this analysis in your company:
As mentioned above, doing a breakeven analysis for a new business is vital in determining profitability and pricing structure.
Whenever you add a costly new product to your business, you need to calculate your BEP to make sure the potential gain is worth the cost.
New sales channel
The costs change when you add a new sales channel. Regardless of whether these costs depend on the channel itself or the associated marketing costs, perform a breakeven analysis every time you add a new sales channel.
New business model
When you move to a new business model, your costs can change dramatically. Do a breakeven analysis to make sure the new model is sustainable.
2 steps to run a breakeven analysis
Hopefully we’ve conveyed the value of this type of analysis no matter where you are in your campaign or business trip.
The following is a breakdown of the steps to run an analysis.
Identify all the expenses you foresee for your business and divide those costs into two categories: fixed and variable.
- Fixed costs: These expenses refer to all expenses that stay the same regardless of the success or failure of your business. Categories include rent, work (if full-time / set), and software subscriptions.
- Variable costs: These costs relate to all expenses that depend on how much you are selling. Take into account materials, payment processing, work (if part time / fluid).
After you’ve found all of these costs, set an average amount for each expense. These are not set in stone, but they should be within the realm of possibility for any commodity.
The formula for breakeven analysis consists of two steps.
- Use this formula to calculate how many breakeven units are required: Fixed costs divided by (sales per unit minus variable costs per unit).
- Determine your breakeven sales volume using Unit price times breakeven units.
This final breakeven sales volume will help you determine if your business is sustainable, if your goals are appropriate, and how to adjust your prices and spend accordingly.
How to Track a Breakeven Analysis
Your breakeven point may not be the last word in the ultimate success of your business, but it is a milestone in the growth of your business.
When launching your campaign, business or product, keep an eye on your breakeven analysis and adjust it as there is revenue or unforeseen expenses.
To keep your analysis updated, you can use Microsoft Excel to work out the numbers for you.
Use Excel’s Destination Finder, a tool that allows users to define either by unit or by price.
The target finder feature allows users to split specific amounts and make verifiable adjustments.
Follow the five steps below to perform this function:
- Enter the terms shown in the image under Step 2 in column A of your table.
- Enter the following formulas to calculate sales, variable costs, and profit
- Sales = Unit Price x Unit Sold
- Variable cost = cost per unit x unit sold
- Profit = Sales – Variable Costs – Fixed Costs
- Choose Data> What-If Analysis> Destination Lookup.
- With the Destination Finder dialog box open, do the following four actions:
- Enter the “Set Cell” as the profit cell (in this example B7).
- Enter the “To value” as 0.
- Specify the “By changing cell” cell as the unit price cell (B1 in this example).
- Choose OK.
With the destination search function of Excel, you can integrate and play different scenarios as required. This tool also enables users to predict what-ifs and plan eventual events.
You can use experiments to prepare your campaign, your company or your product for all eventualities.
What to do if your breakeven analysis was wrong
While breakeven analysis can be of great use in assessing the sustainability of your campaign or project, the formula is not without its limitations.
Unexpected external factors can destroy your formula and lead to incorrect projections and measurements.
These factors can include:
- Lack of demand
- wrong data
- Lack of nuances in the formula
- Time fluctuations
These five factors can have a dramatic impact on your breakeven analysis.
What is on top of these external forces if the result of the breakeven formula is not achievable for your budget?
Should you give up this new advertising channel entirely or give up your dreams of a brick and mortar store?
The answer is no.
Below are three strategies that need to be implemented if your breakeven analysis shows that your next business is unsustainable.
Reduce fixed costs
Is there a way to reduce your fixed costs? Take it. The lower your fixed costs can be, the fewer units you have to sell to break even.
Increase your prices
As you increase your prices, you reduce the number of units you have to sell to break even. A general caveat is to consider the expectations that come with a higher price and what the market will realistically pay. The more you ask, the better the product or service your consumers expect.
Reduce variable costs
Reducing variable costs can be a challenge. The more you can scale, the more you can reduce variable costs. Regardless of what industry you are in, you should change your processes, negotiate with your suppliers or change materials.
Whether it was your first time promoting on Instagram or opening the doors to a brick and mortar store, the accuracy of a breakeven analysis is complicated.
To make sure you get as close as possible to the correct number, it is a good idea to detail the costs and prices that correlate with your business.
In addition to having a thorough understanding of the costs involved in delivering your message or product to consumers, you need to know the right price for your product. Different expenses add up; Take into account all possible variable and fixed costs.
To ensure that you are determining the correct prices for these items, analyze any product, service, or resource that your company uses, produces, sells, or plans to sell. By organizing these items according to profitability priority, you can further reduce costs and potentially reach your BEP sooner.
As you near breakeven point, you should continuously monitor your performance against other metrics. In many cases, breakeven analysis is just one tool that can help your company succeed.
What is your best practice for identifying all variable and fixed expenses?
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