If you listen in on business conversations you will hear lots of talk about breaking even. “What is the break even on that project?” “Will we break even on that investment?”
Who went into business to break even?
The conversations have been about break even so that business leaders know what the minimum level of sales that needs to be achieved so that there won’t be a loss for the day, week, month, year, project, etc.
Here is a simple formula to calculate the Break Even Rate in Sales
Fixed (Overhead) Costs = Break Even Sales
Fixed or Overhead Costs refer to the ongoing expenses of operating a business, such as rent, utilities, telephone, internet, accounting fees, advertising, interest expense, taxes, travel, office supplies, employee benefits and wages not directly associated with the production of a product, etc.
In other words all costs on the Profit & Loss Statement except direct labor, direct material costs or other direct expenses.
If the ABC Company, a manufacturer of widgets has Fixed Costs of $750,000 and a Gross Margin of 25%, then the Break Even is $3,000,000 in Sales.
It is a little less intuitive for a service firm. If the XYZ Law Firm has Fixed Costs of $750,000 and has a Gross Margin of 90%, then it has a Break Even is $833,333 in Sales.
Manufacturers spend a lot of money on direct labor and materials in the production of their products and therefore have a much lower Gross Margin and a much higher break even level than service firms. Service firms have very little in Direct Cost so most of their expenses are Fixed Costs and so they have high Gross Margins.
Let’s go back to the original question, who went into business to break even?
Instead of Break Even set your targets for Acceptable Level of Profit, that is the break even plus an amount of profit that is acceptable to the owners of the business.
Here is a simple formula to calculate the Acceptable Level of Profit
Fixed (Overhead) Costs + Desired Profit = Level Profit in Sales
So if the ABC Company, a manufacturer widgets, has Fixed Costs of $750,000 and the owner wants to make $250,000 in profit and has a Gross Margin of 25%, then the Acceptable Level of Profit Sales is $4,000,000.
If the XYZ Law Firm has Fixed Costs of $750,000 and the owner wants to make $250,000 in profit and has a Gross Margin of 90%, then the Acceptable Level of Profit in Sales is $1,111,111.
Start targeting your Acceptable Level of Profit instead of Break Even; you will be happy that you did.
** Dave Baney is the founder and CEO of 55 Questions, LLC. We work with successful top executives with a driving ambition to crush their competition. We help CEOs and Entrepreneurs improve alignment, communication and accountability throughout their organization. www.55Questions.com **