By G.F. Joey Musmar, CPA, CVA, PFS, ABV
"Is your business profitable?" Most business owners can answer that question with a fair degree of accuracy...for last year. You know how the numbers added up, and whether you were in the black or red. But what about this year? How many product/services will you have to sell this year before you turn a profit? Is your pricing correct? Are you making money now? You can get answers to these questions by knowing your break-even point.
Knowing your "break-even" point is an important business-planning tool. Having an idea of when your costs will be covered and profits begin can help you make better purchasing, staffing, even vacation decisions, and is a vital part of the price setting process. There is a way to determine your break-even point without consulting a crystal ball. Through a simple analysis of three key factors, you can know what it will take this year for your company to make money. Note, we use the words product/service to keep this article generic; you can substitute the appropriate term that best fits your industry (for example, doctors use treatment, restaurants use entree, attorney's use cases, professional services firms use services).
The first factor is the quantity of product/services you expect to sell this year. Analyzing your company's past history and factoring in predicted company performance would provide a fairly accurate gauge of what you'll be selling this year. You can also do this calculation backwards by estimating your revenue for the year and then dividing it by the average sales price of product/services sold.
The next factor is your gross margin per product/service. All retailers, business owners, and dealers continually struggle with pricing. The object is to price your product/service low enough to be competitive, yet as high as possible to make the maximum profit. Too often, this becomes an exercise in guesswork and gut reaction. Worse yet, many business owners simply copy the next guy across the street, without regard to the differences in the two businesses.
The third factor in the break-even equation is overhead costs. These are normally fixed costs that are not affected by changes in revenue. They include rent, payroll, professional services, equipment, interest payments, insurance, taxes, etc. Using figures from previous years will provide an indication of what your expected overhead will be for the upcoming season. We do not include the cost of product/service or owner's salary in this analysis.
At this point you have the information available to establish your break-even point for two critical areas: gross margin and minimum product/services. Your break-even point comes when total overhead cost is met by total gross margin.
As a business owner, you will now be empowered to know at approximately what point you have covered your operational costs and are able to make a profit. In concert with profit margin, you will be able to know how much money your business is generating in your pocket. In other words, if your profit margin is 30% and you just passed your break-even point at the end of the second week of the month, you can safely ascertain that during the last two weeks of the month you will be taking home 30 cents for every dollar of sales your business generates.
How would this work in practice? What are you trying to establish? First, you want to know how many product/services you need to sell at your expected margin in order to break even. Second, you want to determine the minimum margin you need to achieve when you sell the expected product/services so that you will cover costs.
In our version of break-even, we do not include the owner's salary in the overhead expenses, as we consider company profit and any salary drawn by the owner to be part of the overall benefit of ownership. In your analysis, you might decide to include some part of your salary in the calculation. It's up to you.
To be more accurate, we factor in outside influences and market trends. But even in its simplest form, a break-even analysis can be a powerful tool to help you plan your season's buying, and in determining a selling price for your product/service. You have the information on hand to make this analysis, and should take the time to sit down with your CPA to know your "break even" point!
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