Using Breakeven for Decision Making
The term breakeven sales means the dollar amount of sales that exactly covers all expenses resulting in zero profit.
Let’s look at the following example:
|Cost of Goods Sold (variable)||400,000|
|Gross Profit||$ 600,000|
|Operating Income||$ 200,000|
To calculate your breakeven point, take your Overhead and divide by your Gross Margin. In the example $400,000 / 60% = $666,667. That means $666,667 in sales need to be made to breakeven.
Not sure of the calculation? Sales of $666,667 x 60% = $400,000. Subtract the Overhead of $400,000 and you are left with zero profit.
Applying Breakeven to your business
Assume that your average weekly sales is $19,231. At the end of week 35, cumulative sales for the year will be $673,085, or just past breakeven.
That means for the final 17 weeks of the year, 60 cents out of every sales dollar will be bottom-line profit since all overhead has been covered. This is an enviable position to be in. Leverage it for your business by giving sales people incentives to sell above your weekly average weekly sales rate. It’s a win-win for both employer and employee.
Assume that you are considering a new marketing initiative that costs $10,000. The amount of additional sales needed to cover this added cost is calculated using the breakeven sales formula:
|$10,000 divided by 60% Gross Margin = $16,667|
The key question is not whether to spend $10,000. It is whether the initiative will bring you at least $16,667 of added sales. And, how you will track those sales to prove it.
You can make the same calculation when investing in new technology or hiring the next employee. Just remember to factor in any annual costs. A technology purchase may be a one-time investment, but a new employee should be considered an annual cost. Added sales must repeat in succeeding years when you add people or other resources that come with recurring costs.