We have included an easy-to-implement formula for determining whether your pricing and marketing meet your financial breakeven and make-a-profit needs.
Let's say you want to be a consultant of some kind: a bookkeeper, a graphic designer, a website developer, a life coach, or whatever you choose. Three areas should be on your agenda: breakeven, pricing of your services, and the number of clients you need to break even and then make a profit.
As the company's founder, your decision is how involved you are in your company's finances. What is your level of knowledge in this area? Do you have the time to spend on bookkeeping tasks, for example? You can be the person with great ideas that make money, but you don't have to be the person to manage the funds. However, someone or some system must be in place to track it all accurately.
Many entrepreneurs hire an experienced financial professional to handle that part of the business. At the least, you should gather and log in the economic data to send to a bookkeeper, and you should be able to read financial reports.
It takes a while to break even and then make a profit. If you are running an online business out of your home, where you don't have the cost of producing a product, the fixed costs will be much lower, and you will reach breakeven much faster.
Think of it as an investment in equipment, furniture, website, apps, and all the things you need to have to run your business. Even if you have an online business without having to manufacture a product, you will have a ramp-up period.
Most experienced entrepreneurs say you should be able to cover a minimum of one year of personal and business expenses to start a business. So your first goal is to break even.
If you haven't written down ALL of your expenses for the year, you need to do this before you quit a job. Unless you have savings, a partner who can take up the slack, or you will do a side hustle, you need to know how much you will need to cover your expenses. You will probably see where you can cut some of your costs as you do this calculation.
You can figure out your expenses, but what about the business expenses? When you start, you need an easy formula to determine your breakeven, how much you will charge per hour, and how many customers you will need to break even.
What is breakeven? It is when your revenue is covering your expenses. There are four steps to compute breakeven.
- Add up your fixed costs
- Track the price of your services
- Identify any variable costs
- Determine breakeven
Step 1. Add up Your Fixed Costs
The fixed costs are the regular costs you have each month to run your business. These are costs like salaries, freelance services, rent, utilities, insurance, online app subscriptions, website development, maintenance and hosting, professional memberships, advertising and marketing, professional services such as lawyers, bookkeepers, accountants, educational expenses to learn new programs and apps, and licensing fees.
You may or may not be paying yourself a salary. If you plan to take a wage out of business from the beginning, add that in. If you can defer a wage and take profits over a certain threshold after covering your expenses, you will break even much faster.
You may want to include a basic amount to pull out of the business regularly. Consider your legal structure, whether you have anything left after you cover your expenses, and whether you pull the same amount out each month.
Step 2. Track Your Revenue
You will need to establish a price for your services. The price for your services will depend on how you charge. Are you charging an hourly rate, a flat rate for a service, or a mix of the two.
Regardless, you have to figure out your average rate per job. For example, you may charge an hourly consultant rate to your clients. But you also offer a monthly meeting for an additional cost. And perhaps you sell a course to the same client.
You can categorize it by the client or by type of service. As you "hit your stride" and become well-known for your service, you may also increase the prices.
To price your services, you should gather data on competitors to determine the range for the cost of the services you are offering.
Let's say you set your price at $50.00 per hour. You can use that figure in your calculation to see how many hours (or courses, etc.) you will have to sell to reach breakeven.
If you have more services that one, with about three months' experience, you will be able to determine a more accurate average.
Step 3. Identify Variable Costs
Variable costs are expenses associated with that particular client you are serving. Perhaps servicing that client requires traveling to their business. Your travel costs would be a variable cost with that client.
Another example is if you hired a contractor to do that job. You would subtract out the contractor's fee as a variable cost because that contractor did the work specific to that client, not all your clients.
You might have had to purchase materials or equipment related to the client. Think of anything that would have been out-of-the-ordinary and relate to that client.
You may have several variables for a job, and you want the average variable for the job.
For example, you have a client who wants 4 hours a month @ $50 per hour. That equals $200. However, you had a specific expense with that client of $40. The $40 was the variable cost for that month. So you didn't clear $200. You cleared $160. That's the effect of the variable cost related to that client.
Step 4. Calculate Breakeven
The formula for calculating breakeven is Fixed Cost / (Fee – Variable Costs.)
For example, your total fixed costs are $3000 per month or $36,000 per year.
The average fee for your services for one client is $200 a month per job/client (you have been selling four hours a month of your services @ $50 per hour) and your variable costs are averaging $40 per client). Therefore, your net per client, per month is $160 per client or $1920 per year.
Fixed cost of $36,000 / Net Job (Price-Variable) of $160 = 225 jobs
Conclusion: You would need 19 clients each month (225 job divided by 12 months) for all 12 months at these rates and hours to break even for the year.
Further Explore Contribution and Profit Margin
The contribution margin for each product line is important to know whether a product line is contributing profitably to your business. Let's say we have three products, a book, a course, and a coaching service. I want to know which product is the most profitable, so you want to know what percent each product/service is contributing to your profit. You should explore how the contribution margin and the profit margin operate when you have more than one product/service.
Here's an article on understanding contribution margins: https://hbr.org/2017/10/contribution-margin-what-it-is-how-to-calculate-it-and-why-you-need-it
From this data, you can determine if you need to raise your prices or step up or change your marketing tactics.