A common question among business owners is how to determine the “breakeven point,” which is the level of sales needed to cover all company expenses. To calculate this, you need to break down expenses into three categories: (1) Cost of Goods Sold (COGS), (2) Overhead Expenses, and (3) Payments to Owners.
1. Cost of Goods Sold (COGS) or Variable Costs
First, calculate your COGS percentage. COGS varies with revenue, but the percentage relative to revenue remains stable. By analyzing past years, you can find the average COGS percentage by dividing total COGS by total sales. This allows you to determine your gross profit percentage—what remains after subtracting COGS from revenue. For instance, if your COGS percentage is 40%, your gross profit percentage is 60%. This means for every dollar in revenue, the company earns 60 cents to cover other expenses.
2. Overhead Expenses or Fixed Costs
Overhead expenses are constant regardless of revenue. Examples include rent and administrative salaries. Review historical data to estimate average annual fixed costs.
3. Payments to Owners
Payments to owners can vary depending on the company’s structure and agreements. It’s helpful to separate these from overhead expenses.
Calculating the Breakeven Point
Start by summing your annual overhead expenses. For example, if these total $500,000 and owner payments are $250,000, the company needs a gross profit of $750,000 to cover both overhead and owner payments.
Next, calculate the required gross revenue. With a gross profit percentage of 60%, you need $1,250,000 in gross revenue to achieve a gross profit of $750,000 ($750,000 divided by 60%).
Test Scenario
- Gross Revenue: $1,250,000
- COGS (40%): -$500,000
- Overhead Expenses: -$500,000
- Payments to Owners: -$250,000
- Net Profit (Loss): $0
In this example, a sales revenue of $1,250,000 hits the breakeven point. For any revenue above this amount, the company will earn a profit of 60 cents per dollar, as COGS is 40% of gross revenue while overhead and owner payments remain fixed.
If you have any questions in calculating your company’s breakeven point, feel free to contact your ShindelRock professional [1], and we would be happy to assist you!