The Complete Idiot's Guide to Best Practices for Small Business by Gina Abudi

Author:Gina Abudi
Language: eng
Format: epub
Publisher: Penguin Group USA, Inc.
Published: 2011-09-08T00:00:00+00:00

Determining Your Profitability

Conducting a break-even analysis assists you in determining how many sales you need to break even (no net loss or gain) and to begin to make a profit for your business.

DEFINITION

A break-even analysis is a technique used to analyze how much you need to generate in sales in order to achieve enough revenue to pay expenses and generate a profit.

By using a simple spreadsheet, you can determine how many sales you need to make of each product and service to offset your variable and fixed costs. This is your break-even point. Once you understand how many sales you need to make to cover all of your expenses, you can then determine how many additional sales are required to begin to make the desired profit for the business.

Let’s look at an example. Assume your break-even analysis shows that for you to cover your expenses you need to sell 25 widgets in a month. If you sell more, you begin to make a profit. You would like a profit of at least $5,000 each month to invest in research and development. To gain this much profit, you will need to sell 100 additional widgets each month. If you do not believe you will be able to sell 125 widgets in a month, you need to find other ways to make your profit of $5,000. This might include reducing your costs of producing widgets by negotiating with suppliers of your material or increasing the price of your widgets in the marketplace.

Determining your profitability requires you to have an understanding of two types of costs for your business: fixed costs (costs that remain the same no matter how much of a product you sell, such as costs for rent for your storefront—these costs must be covered even if you don’t sell anything) and variable costs (costs that change depending on the number of products you sell, such as material costs or sales commissions).

Use this formula for your break-even analysis:Break-Even Point = Fixed Costs ÷ (Revenue Per Unit Sold–Variable Costs Per Unit)

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