The break-even point is the moment when your company makes enough money to cover its costs. Past this point, your company starts to make a profit. Finding the break-even point through a cost analysis is one of the most valuable processes a builder can undertake. It helps answer key questions like:
- What volume of sales do I need to break even?
- What profit can I expect from a specific volume of sales?
- What price should each project be sold at?
- Should marketing or other overhead costs be adjusted?
This guide will walk you through how to perform a break-even analysis specific to custom homebuilders, using average numbers for simplicity.
Step 1: Separate Variable Costs from Overhead (Fixed Costs)
Start by separating all costs into two categories:
- Variable Costs:
These are direct project costs, such as:
Materials: Lumber, concrete, fixtures, etc.
Labor: Builder and subcontractor wages.
Subcontractor Services: Plumbing, electrical, HVAC, etc.
In this example, the variable costs per home are $598,778. - Fixed Costs (Overhead):
These are operational expenses necessary to run your business but not tied to any specific project. They include, licensing fees, insurance, salaries, office rent and utilities, marketing & professional services, etc.
In this example, total annual overhead costs are $748,000.
Step 2: Calculate the Contribution Margin
The contribution margin shows how much profit each home sale contributes toward covering your fixed costs after subtracting variable costs. Here’s how to calculate it:
Contribution Margin=Selling Price per Home−Variable Costs per Home
For example:
- Selling Price per Home: $765,000
- Variable Costs per Home: $598,778
Contribution Margin=765,000−598,778=166,222
Contribution Margin: $166,222
Step 3: Find Your Break-even Point
To calculate how many homes you need to sell to break even, divide your total fixed costs by the contribution margin:
Break-even Point (Units)=Fixed Costs (Overhead)/Contribution Margin
In this case:
Break-even Point=748,000166,222≈4.5 homes
This means you need to sell approximately 4.5 homes per year to cover both direct and operational costs.
Step 4: Profitability Beyond Break-even
If your business sells more than the break-even number of homes (e.g., 7 homes), you can calculate your profit like this:
- Total Revenue (7 homes): $765,000 x 7 = $5,355,000
- Total Direct Costs (7 homes): $598,778 x 7 = $4,191,446
- Gross Profit: $5,355,000 – $4,191,446 = $1,163,554
- Net Profit (after fixed costs): $1,163,554 – $748,000 = $415,554
By selling 7 homes at an average price of $765,000, your net profit would be $415,554.
Understanding your break-even point and the number of homes you need to sell helps you manage your business more effectively. By focusing on the number of homes sold, you can make more informed decisions about pricing, costs, and profitability. This example uses average numbers for simplicity, but you can adjust the calculations to fit your specific financial situation.