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Calculating breakeven sales is a critical business skill

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Calculating breakeven sales is a critical business skill

With capital as tight as it is and revenues for many companies down, calculating your company’s breakeven sales is a skill that can help you better plan and manage your fixed and variable costs. 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 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. 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 losing money. Here is the formula for calculating breakeven sales:

Breakeven Sales ($) = Total annual fixed costs
Contribution margin / Annual sales revenue

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:

Breakeven = $80,000 / ($80,000/$200,000)
Sales of = $80,000/ 0.40
($16,666) per month = $200,000

The breakeven point in this example is $200,000. If monthly sales are relatively equal, the monthly breakeven point is $16,666 ($200,000 / 12). The adage “garbage in, garbage out” is applicable here. Make sure to accurately total all estimated fixed and variable costs and to be realistic about your annual total sales.

Additional Considerations for Calculating Breakeven Sales:

  1. Account for Seasonal Variations: If your business is seasonal, adjust your sales and cost estimates to reflect these fluctuations. This can affect your calculation of monthly breakeven sales.
  2. Monitor Regularly: Regular monitoring of your breakeven point is vital, especially if your costs fluctuate or if you introduce new products or services.
  3. Plan for Contingencies: It’s wise to include a buffer in your calculations for unexpected costs or downturns in sales. This can help you manage risks more effectively.
  4. Use Breakeven Analysis for Decision-Making: Breakeven analysis can be a powerful tool for decision-making, such as evaluating the profitability of adding a new product line or scaling operations.
  5. Impact of Fixed Cost Changes: Be aware that significant changes in fixed costs, such as rent increases or new salary commitments, can dramatically alter your breakeven point. Regular updates to these figures are crucial for accurate planning.

Understanding these factors can greatly enhance the utility of the breakeven analysis, helping business owners make informed decisions that align with their financial targets and market conditions.

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