Small business owners who are struggling with profitability should calculate their breakeven sales so they have an accurate understanding of how much they need to sell each month in order to make a profit.
The exercise is pretty easy but you have to know some terminology:
Annual fixed cost: This is the total of all business overhead costs anticipated on an annual basis. These are costs like rent, insurance, property taxes, some salaries, and any expenses that aren’t tied to making or selling your product.
Annual variable cost: This is “cost of goods sold,” which includes raw materials, direct labor, sales commissions, sales related expenses, freight, and the energy costs associated with making a product.
Contribution margin: This is the amount of money in annual sales revenue that exceeds annual variable costs. It is called contribution margin because it contributes toward paying fixed costs.
Annual sales revenue: This is the revenue from selling your product or service. In order to calculate your company’s breakeven point, you must estimate your annual sales as accurately as possible.
When the contribution margin exceeds fixed costs a company has a profit. When contribution margin is less than fixed costs the company is loosing money.
Here is the formula for calculating breakeven sales:
Total annual fixed costs
Contribution margin / Total sales
Using an example of a company that is projecting annual fixed costs of $80,000 per year, variable costs of $120,000 / year, and anticipated total sales of $200,000 the calculations would look like this:
$80,000 / ($80,000/$200,000)
In this example the breakeven point is $200,000. If sales per month are relatively equal, the monthly breakeven point would be $16,666 per month ($200,000 / 12)
The phrase garbage in, garbage out applies here. Make sure you total all your estimated fixed and variable costs as accurately as possible and are realistic about your annual total sales.
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