Where do my sales need to be in order for my company to breakeven?
This is a very common question many business owners ask. The “breakeven point” is a crucial figure since it quantifies the amount of sales needed in order to cover the expenses of the company. In order to determine your company’s breakeven point, you will need to separate the company’s expenses into three categories: (1) cost of goods sold, if applicable (2) overhead expenses (3) payments to owners.
Cost of Goods Sold (COGS) or Variable Costs
First you will need to determine your COGS percentage. The amount of these expenses change with the revenue of the company, however the percentage of these costs to revenue remains constant. Taking a look at the prior couple of years, you can determine the company’s average percentage by dividing the total COGS by the total sales. Once you know the COGS percentage, you will be able to determine the “gross profit” percentage, which is the company’s profit remaining after the cost of the sold product is subtracted from revenue. For example, if your COGS percentage is 40%, then your gross profit percentage is 60%. This means that for every dollar of revenue earned, the company makes 60 cents. That 60 cents is what can be used to pay for the other overhead expenses and payments to owners of the company.
Overhead Expenses or Fixed Costs
These are the costs that remain constant regardless of the amount of revenue earned by the company. Rent and administrative salaries are good examples of costs that remain at a fixed amount. Again, by looking at the historical fixed costs of the company, you can get a rough idea of what the company’s average fixed costs are per year.
Payments to Owners
Depending on the agreement of the owners and/or the setup of the company, this amount can vary. So many times, it is helpful to separate the payments to the owners from overhead expenses.
Calculating the Breakeven Point
Once you have your expenses separated into the above categories, add up the company’s total overhead expenses (fixed costs) for the year. Let’s say these add up to $500,000. The next step is to determine what amount the owner payments needs to be. Let’s say this is amount is $250,000. So, the company will need to make a gross profit of $750,000 to cover the overhead expenses of the company as well as payments to the owners.
Now that we know what the gross profit needs to be, we can simply back into the gross revenue needed. If your average gross profit percentage is 60% (as seen in the above example), you will need gross revenue of $1,250,000 ($750,000 divided by 60%) to cover the COGS, overhead expenses, and payments to the owners. Finally, once you calculate this number, run a test scenario starting with gross revenue.
Gross revenue: $1,250,000
COGS (40%): ($500,000)
Overhead expenses: ($500,000)
Payments to owners: ($250,000)
Net profit (loss): $0
As you can see, sales of $1,250,000 for the company in the example is the breakeven point. For every dollar of gross revenue earned in addition to $1,250,000, there will be a profit of 60 cents. (COGS remains 40% of gross revenue, however, overhead expenses and payments to the owner will not increase as a result of increased gross revenue.)
If you have any questions in calculating your company’s breakeven point, feel free to contact your ShindelRock professional, and we would be happy to assist you!