If someone were to ask you, “How do you know if your business is profitable?” you will show him the Net Profit number from your Profit and Loss Statement to see whether it was positive or negative for the period under review.
What if someone were to ask you, “When do you start making money in your business?” what will be your answer and where would you find it?
Not surprising, most business owners are just too caught up with the answer to the first question but place very little emphasis on the answer to the second question which we deem to be more critical in guiding any business of any size to prosperity.
Yes, your answer to the second question is MORE important than your answer to the first question. Period.
So, what is the answer to the second question? Your Break-even Point.
Do you know the Break-even Point of your business on a daily basis?
Do you know which of your products and services contribute to your Break-even Point?
Do you know how much of your products and services are needed to achieve this Break-even Point on a daily basis?
Whenever I asked business owners these few questions, they would either give me a blank stare, or just referred me to their Accountants. Responses like these usually frustrate me. However I cannot blame those business owners because they still hold the mindset that their Accountants would give them the answers when the need arises. This mode of running a business is similar to walking on thin ice.
We must understand that Accountants are certified on the basis that they are good at collecting past data, collating those data, and submitting them to the proper tax authorities under the latest applicable laws. Period. This is the main job of any Accountant on earth!
To me, Accountants are like historians. By the time you ask them for answers, you are already history. (No offence if you are an Accountant reading this article)
There are several steps you can take to calculate your Break-even Point. The more you do this, the sharper you would become and your business would become more profitable.
Step 1) Know the COGS (including all variable costs) of each product or service rendered;
Step 2) Determine your selling price for each product and service;
Step 3) Did you get a margin of between 30% to 45%? (This is what we call a Margin Test) and
Step 4) Know all the Fixed Costs in your business. (Be ruthless here)
The formula to calculate your Break-even Point is as follows;
Total Fixed Cost/Margin Contribution per Unit = Sales Volume Needed
Your goal is to have a low number of Sales Volume needed to achieve your Break-even Point daily. The lower the better. Based on the formula, you have 3 ways to achieve a low Break-even Point for your business as follows;
Way 1) Lower your Total Fixed Cost;
Way 2) Increase your Margin per unit; and
Way 3) A combination of Way 1 and Way 2.
If your business sells multiple products and services concurrently (which business doesn’t), you may use the average prices, margins, and costs to determine your Break-even Point for your business.
Granted, the Sales Volume to achieve your Break-even Point is the most important number you want to know daily to keep you business on track and to ensure continual profitability.
I hope this article would prove useful in helping you determine your Break-even Point for your business if you have not done so yet.