It's one thing to have a sales target in a business, most would be impressed if you stated you had a high revenue. What is more important; Big revenue or big profits?
Well, of course, big revenue without profits is useless, unfortunately many business people do not get it! So I am going to do my best to explain to you how to work out when you are making a profit, it is called your 'break even point'. This is the point when you have covered your fixed expenses and you start to make a profit.
Before we can begin to understand how to calculate your break even point we need to make sure you have an understanding of your profit and loss (P & L) statement. We will then use figures from your P & L to determine your break even point. We can also have a look at the effects of selling higher margin goods and services to your break even point.
Your P & L records the following information. Sales, sometimes referred to as income, COGS or COS (cost of goods sold, cost of sales), Gross Profit, Fixed Expenses and finally, Net Profit or Loss. For you to work out your break even point you will need to make sure the information recorded on your P & L is correct. Otherwise, you will be working with incorrect numbers.
The first step to working out your break even is to work out your gross margin as a percentage. To do this, take your total sales and subtract your cost of sales, divide the result by your total sales, then multiply by 100. As an example, say you had sales of $ 500k and your cost of sales was $ 300k. Eg. ($ 500k – $ 300k = $ 200k) $ 200k / $ 500kx 100 = 40%. So you now know that your gross margin is 40%, this means that for every dollar of sales, you get to keep 40 cents as gross profit. Now we know our gross profit we can work out our break even point (the point that all fixed expenses are covered and you start making profit).
To work out your break even point you take your total fixed expenses and dividend by your gross margin percentage and multiply by 100. As an example, let's say your fixed expenses are $ 150k and your gross margin is 40%. Eg. $ 150k / 40 x 100 = $ 375k, so you're break even point will be $ 375k. This means that you will started making Net Profit after you have sold $ 375k of products or services.
Once you have worked this number out you can work out your monthly, weekly, daily or even hourly break even sales by dividing the break even amount accordingly. Let's say that $ 375k is your annual break even, divided by 12 will give you $ 31,250. This is your month break even. Take $ 375k and divide by 52, this will give you your weekly break even.
Next, work out the difference if you had a higher gross margin percentage. Imagine all the numbers are the same except you have a gross margin of 48% instead of the 40% we used in the previous example. Using the formula from above, (total fixed expenses and dividend by your gross margin percentage and multiply by 100) $ 150k / 48 x 100 = $ 312,500. Over $ 50k less needed in sales to Break Even! A great reason to focus on selling higher margin goods and services!
So there you have it … a simple way to calculate when you start to make money!