Sales, profit and cash are the key issues to focus on in financial management. If you can get these three areas right you’re on your way to building a sustainable business with capacity to grow.
What’s your break even point?
Most businesses focus on sales to begin with when they should start with profit – if you’re making sales without profit you will go out of business. The best way to start making enough profit is to avoid losses, so it’s crucial to understand break-even sales.
Break-even sales are the number of sales you need to make to avoid a loss i.e. to achieve a $0 profit or loss result. This is affected by fixed and variable costs. Fixed costs are those that do not change much, e.g. rent, insurance, and telephone. Variable costs are those that vary when making a sale, e.g. a product and associated costs like wages, freight, and packaging. If you’re selling a service the variable costs are labour and materials used on the job.
When you’ve calculated the variable costs per product or job, you can then calculate gross margin. For example if a product costs $40 (including all costs associated with getting the product ready for sale) and you’re selling it for $100, the gross profit margin is 60%.
To work out break-even sales if your fixed costs are $30,000 per month – divide that by gross profit margin of 60%, which gives a figure of $50,000. This is your monthly break-even total sales. If your average product sale is $100, divide the total sales break-even figure of $50,000 by your average sale of $100 to come up with a figure of 500 units to break even. This means you have to sell 500 units per month at $100 per unit to break-even.
Now you know your break-even point, you can use this as a basis for setting targets to achieve your desired profit. For example, for every additional unit you sell above the break even volume of 500 units, you will make $60 profit, which is the gross margin per unit of sale. Therefore if your target is to make a $6000 profit you will need to sell an additional 100 units.
Gross profit margin is one of the most important figures in business. If you can’t make a decent gross margin, it is difficult to make a net profit. One of the biggest issues in financial management is the lack of understanding of the ‘true cost’ of a product or service. It’s often thought of as just the raw cost of the product or service. Items such as freight inwards, wage on-costs, and packaging are often wrongly omitted when calculating cost. This is dangerous, because it means when pricing a product and calculating a margin the true cost isn’t accounted for.
In this case the gross profit margin suffers and this reduces what’s available to cover fixed costs. The result is losses and the constant need to focus on more sales to meet cash flow needs.
C & N Business Advisory can conduct a review of your situation and calculate your true break even point, Gross Margin, and net profit potential. Call us today for a free one hour consultation – 1300 250 122
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