How much money is needed to pay the business bills? How many sales are needed to reach that amount? The answers to these two questions are important to have a good handle on.
Any business has costs to cover to stay operational Cost might include any or all of the following:
- Telephone line rental
- Internet service provider
- Office space rental
- Stock or raw material purchase
Business costs are classified by the following:
- costs that do not change according to the sales made or goods produced, e.g. rental costs, loan repayments.
- costs that vary in direct proportion to sales and amount of good produced, e.g. raw materials, sales commissions.
Whichever category they fall into, costs need to be met. Working out the sales figure you need to cover the necessary operating costs gives the break-even figure. Anything earned over and above this figure is profit.
Knowing this figure gives you a target to shoot for and measure performance by. If your break-even costs are not being exceeded--you are making no profit--immediate, corrective action needs to be taken to do any or all of the following:
- Increase sales
- Increase average revenue per sale
- Increase customer purchase frequency
- Increase individual spend amount
- Reduce costs
Often the immediate reaction to not meeting break-even figures is to reduce costs by making cutbacks and increase pricing. But this needs to be a last resort measure. Cutting back on staff or product quality can have a direct flow on effect to workers morale and customer service, which will compact the lack of sales issues. The optimal solution is to sell more. Study the marketing package and see where you can focus. See where trends are flowing and take the products to them, or put strategies in place to sell more to the individual.
Determine which product or service your business makes the most from and target that at customers in and out of the store. For example, a pub actually makes more money on a glass of soft drink that they do beer. So more reasons for families to come for meals, the more cordial will be sold. In addition, as one of the cheapest products to produce it is the most cost effective to use as encouragement to buy other products such as a free soft drink with every kid's meal.
Calculate the fixed costs, as these do not change frequently. These are also called overheads or indirect costs and include such things as rent, wages, insurance, loan repayments.
Calculate your variable costs. These do vary according to sales and how much product you need to supply on any given day, or week. Items in this could be raw materials used to produce your product, sales commissions paid, packaging, and shipping. These can also be known as direct costs. They vary in direct proportion to activity levels within the business.
Your monthly breakeven figure is:
Total monthly fixed costs + total monthly variable costs
Calculate the average value of each sale you make by adding total sales revenue for the month and dividing by the number of sales transactions that month. A period of 3-4 months may give a more accurate figure to work with.
The number of sales you need to make to reach your break-even figure is:
Breakeven figure ÷ average sales revenue = number of sales required
A number of useful free templates, including one for break-even analysis, are available from the Microsoft Office Online website.
Other useful calculations
Your gross profit
is: Total sales revenue - variable costs
Your gross profit margin
is: Gross profit ÷ total sales revenue,(multiply the answer by 100 to express as a percentage).
Gross profit margin shows how much remains from sales after breakeven costs are met.
Your net profit
is: Total sales revenue - variable costs - fixed costs
Your net profit margin
is: Net profit ÷ total sales revenue
(multiply the answer by 100 to express as a percentage).
Net profit margins indicate how effective the cost control is. The higher to net profit margin the more effectively revenue is being converted into actual profit.