The best way to avoid business losses is to understand what your break-even point is.
Obviously the objective of business isn’t to break-even, but to make a profit.
Break-even is the amount of sales you need to make to end up with $0 profit.
Too many businesses don’t know their break-even point and therefore don’t set targets weekly/monthly to ensure they are profitable. A great start to profitability is to know what your break-even point is.
Once you know this, you can use it as a basis for setting your targets of profitability. You can give each salesperson, division or team, individual targets to achieve overall profitability.
- Break-even is impacted by fixed and variable costs.
- Fixed costs are those that you incur all the time, e.g. rent, admin wages, telephone etc.
- Variable costs are those incurred in making a sale, e.g. a product and associated costs like freight inwards, packaging etc.
- If you’re selling a service it’s labour and materials on the job.
When you’ve calculated variable costs per product or job you then calculate gross margin.
For example if a product costs $40 (including all costs associated with getting the product ready for sale) and you’re selling it for $100, gross margin is 60%.
Now you need to know fixed costs. Let’s say they are $30,000 per month.
- To work out break-even sales – take fixed costs of $30,000 divided by gross margin of 60%, which gives a figure of $50,000. This is your monthly break-even total sales.
- If your average product sale is $100, divide the total sales break-even figure of $50,000 by your average sale of $100 to come up with a figure of 500 units to breakeven.
- In simple language this means you have to sell 500 units per month at $100 to break-even.
Now you know your break-even, use this as a basis for setting targets to achieve your desired profit.
For example – with every additional unit you sell above the break even volume of 500 units, you will make $60 profit, which is the gross margin per unit of sale.
Therefore if you target to make $6000 profit you will need to sell an additional 100 units.