What's the Make or Break Point for Your Business?
Sometimes you ask yourself, 'Is it all worth it?' Or if you don't ask this question, perhaps you should. It's an important one for your business.
Ask yourself, 'Is it worth making this product?' or 'Is it worth providing this service?' If the answer is no, you might want to think about changing your product line or refocusing your business.
One of the tools that can help you get an answer is a breakeven analysis. Breakeven analysis tells you how much you need to sell to at least cover your costs. It's pretty crucial to know the breakeven point for what you offer and even for your business as a whole. If you fall below it, you're making a loss and you may be on the top of a slippery slope.
If you want to calculate a breakeven point for a product, you need to consider its sale price and its variable and fixed costs. The variable costs are the ones that increase in direct proportion to sales volume. Say you sell soap, for example. You currently sell it at $1.50 a pack.
Your variable costs might include:
- the price of packaging that you buy from your suppliers;
- the raw materials you use to produce each pack;
- transport costs; and
- sales commissions.
Say your variable costs amount to 50 cents per pack. That leaves you with a margin of $1 on each pack you sell.
To find your breakeven point, you then calculate how many packs you need to sell to cover your fixed costs-which are the costs that remain constant regardless of your sales volume.
Your fixed costs could include:
- the rental you pay for your factory;
- insurance costs;
- loan repayments;
- salaries for your core team members; and
- plant costs (provided that you don't make major purchases).
Say your fixed costs are $50,000 a quarter. Remember that your margin after paying variable costs was $1 per pack. So you'll have to sell 50,000 packs a quarter just to cover your fixed costs.
If you fall below that point, alarm bells should start to ring. In fact, they should start to ring well before you reach the breakeven point, because you'll be eating into your overall profit margin.
Breakeven analysis is also an important part of business planning. Say you're looking at launching a new product. You're not sure how to price it so you do some research. You carry out some calculations to estimate how price sensitive it is.
For example, will demand drop off suddenly if there are small price increases? (This commonly happens if you are selling discount goods and you are competing mainly on price.) Or can you price at a range of levels with only a moderate decline in demand and sales? You can estimate a kind of price/demand curve that will tell you how a product might sell at a range of prices. Then you can carry out breakeven analyses for a range of points on this curve. This will help you make decisions about pricing, production volumes and profit.
If this sounds like it might be getting a little complex, perhaps you're right. We are only a phone call away and we have a proprietary software program ( Targeting Business Results Plus) that can help carry out and track these important business calculations. When you call, you can also ask about our Effective Financial Management seminar, which covers breakeven analysis and a host of other useful financial management concepts.