| Breakeven analysis answers the question,
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| | equipment loans, or mortgages - it is a
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| "what do I need in sales in order to
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| | good idea to include the principal
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| break even?" By breaking even, we mean
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| | payments as part of your breakeven
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| not losing any money, but also not making
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| | calculation.Some improvements to the
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| any money. The breakeven sales amount is
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| | breakeven calculation The examples below
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| commonly referred to as your monthly
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| | are from an Excel spreadsheet built to
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| "nut". If sales are below this amount,
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| | take care of these problems. You can
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| you feel bad, if they are higher, you
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| | download the Excel spreadsheet by
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| feel good. Unless you use Enron type
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| | clicking on this link: Breakeven There
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| accounting, or are swimming in debt, you
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| | are four basic inputs from your Income
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| should be able to work out the cash flow
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| | Statement needed to calculate
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| to sustain your business if you are
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| | breakeven:SalesCost of SalesOther
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| consistently profitable.Of course, you
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| | Variable Costs (to catch truly variable
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| want to make a profit, not just break
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| | costs such as commissions that may not be
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| even month after month. So you can use
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| | included in "Cost of Sales")Fixed
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| this type of analysis to set a profit
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| | CostsThe Excel example shows six months
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| goal, and figure out what your sales
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| | of data for a hypothetical company with
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| should be to reach that goal. The
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| | fixed costs of $20,000 per month, the
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| Breakeven Coverage Ratio is another way
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| | same for all six months. But because the
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| of stating a profit goal.Recently, I had
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| | mix of sales varies from month to month,
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| a client ask me to figure out what his
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| | the gross margin is anywhere from 60% in
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| Breakeven Sales were for him. I thought
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| | month 1 down to 48.15% in month 6. Total
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| to myself - "why can't you do that
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| | variable costs as a percentage of sales
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| yourself? It's not exactly rocket
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| | range from 50% to 61.48%. As a result,
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| science."But maybe it is not so obvious.
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| | "Breakeven Sales" ranges from $40,000 to
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| There are some nuances for a small
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| | $51,293.The Breakeven Coverage Ratio is
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| business that can make the calculation
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| | simple the "Actual Sales" for the month
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| difficult. The key is to separate your
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| | divided by the "Breakeven Sales." This is
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| costs into fixed and variable portions.
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| | a measure of how well you've got your
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| The variable costs are those incurred
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| | breakeven covered. Depending on your type
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| only when a sales is made. Then you do a
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| | of business, a coverage ratio of 1.25 or
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| little algebra.If you are a retailer or
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| | better is considered good.3 Month Moving
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| wholesaler, your variable costs would be
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| | Average To answer the question, "what is
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| the cost of goods that you re-sell, plus
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| | my breakeven?" - a moving average is
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| perhaps some credit card charges, and
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| | helpful to smooth out the variations in
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| maybe commissions.For a service company,
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| | costs and margins from month to month.The
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| you may have no variable costs, or
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| | owner of this company would feel
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| perhaps just commissions, or maybe
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| | confident saying his breakeven is about
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| sub-contract labor. When you are small,
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| | $45,000 per month. The breakeven coverage
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| salaries are not variable over small
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| | ratio of 1.21 is a little below the
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| increments in sales. You make do with the
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| | target of 1.25 or higher.Breakeven before
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| work force you have.Fixed costs are
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| | Owner's CompensationIf the owner is
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| things like rent, utilities, telephone,
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| | drawing $5,000 per month in compensation,
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| salaries, and benefits. For a basic
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| | you can back that out of fixed costs to
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| breakeven analysis, we consider costs as
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| | calculate Breakeven before owner's
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| fixed if they don't vary with small
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| | compensation.Notice how this lowers the
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| increments of sales. Obviously, if your
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| | breakeven quite a bit.Cash Breakeven If
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| sales quadruple, you would need to add
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| | you are paying back a loan, the "Cash
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| staff and incur other costs that are
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| | Breakeven" may be more important to you
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| fixed in the short term. But for the
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| | than the "Sales Breakeven." Just add back
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| purposes of a breakeven analysis, we
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| | the principal portion of the loan to the
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| consider these costs to be fixed.For a
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| | figure for total fixed costs (the
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| simple breakeven analysis, we use the
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| | interest will already be included in
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| formula:"Breakeven Sales" = "Fixed Costs"
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| | fixed costs) before calculating the
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| / (1 - "Variable Cost % of Sales")For a
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| | breakeven. You can see what this does to
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| profit goal expressed as Return on Sales
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| | the breakeven coverage ratio below - now
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| (ROS), we use this formula:"Sales" =
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| | the company is barely breaking even.What
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| "Fixed Costs" / (1 - Variable Cost % of
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| | if?A key reason to look at breakeven is
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| Sales"- "ROS %")(see the derivations of
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| | to understand how much you have to sell
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| these formulas at the end of this
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| | to in order to sustain the business. You
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| article)Example 1 - a Services
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| | also want to know what that figure will
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| CompanyFixed costs are now $30,000 per
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| | be as you hire people, acquire more
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| month. During the last 6 months, variable
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| | space, or buy new equipment. To calculate
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| costs amounted to $32,000 on sales of
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| | the breakeven for a future month, you
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| $200,000. You calculate your "Variable
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| | need to make just two assumptions:Fixed
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| Cost % of Sales" to be 0.16 ($32,000/
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| | costsVariable Costs as a % of SalesYou
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| $200,000 or 16%) - which is for
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| | can look at the year to date average, or
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| commissions and credit card fees. Your
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| | a 3 month moving average to decide on
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| breakeven is $30,000 / (1 - 0.16) =
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| | what to use for these numbers. Then bump
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| $30,000 / 0.84 = $35,714.What will your
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| | up the fixed costs by the cost of the new
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| breakeven be if you add a salaried sales
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| | person, or the increase in rent, and you
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| rep at $5,000 per month (including FICA
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| | have a new breakeven.In the Excel
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| and benefits)? It is $35,000 / 0.84 =
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| | example, we pick the 3 month moving
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| $41,667, an increase of $5,953.What sales
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| | average of 55.85% for "variable costs as
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| do you need to produce a 10% return on
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| | a % of sales", not too far off from the
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| sales after adding this salaried rep? It
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| | year to date average. We increase the
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| is $35,000 / (1 - 0.16 - 0.1) = $35,000 /
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| | fixed costs by $5,000 to reflect the
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| 0.74 = $47,297.Example 2 - a
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| | hiring of a new person, and the resulting
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| RetailerFixed costs are now $30,000 per
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| | breakeven is $56,625.How the formulas
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| month. You thought that your "Variable
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| | were derivedFirst, let's state the
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| Cost % of Sales" was 50% because your
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| | fundamental calculation of
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| standard markup is 2 times cost. But,
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| | profit:"Profit" = "Sales" - "Fixed Costs"
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| based on the last 6 months of actual
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| | - "Variable Costs".Furthermore: "Variable
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| financial results, you calculate your
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| | Costs" = "Variable Cost % of Sales" *
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| "Variable Cost % of Sales" to be 0.58
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| | "Sales"So: "Profit" = "Sales" - "Fixed
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| (i.e. 58%) - because of markdowns and
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| | Costs" - "Variable Cost % of Sales" *
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| credit card processing fees. Your
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| | "Sales"Now its time to consult with your
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| breakeven is $30,000 / (1 - 0.58) =
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| | 12 to 14 year old to solve this equation
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| $30,000 / 0.42 = $71, 429.You figure it
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| | for Sales algebraically:Breakeven For
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| will cost you $3,000 a month to extend
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| | breakeven, we want Profit to be zero. So
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| your store hours by 10 hours a week. How
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| | now we have:(1) 0 = "Sales" - "Fixed
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| much additional sales will you have to
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| | Costs" - "Variable Cost % of Sales" *
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| generate to cover the additional costs?
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| | "Sales"To get all the Sales terms on the
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| It is $3,000 / 0.42 = $7,143. Your total
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| | same side of the equal sign:(2) "Fixed
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| breakeven would then be $33,000 / 0.42 =
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| | Costs" = "Sales" - "Variable Cost % of
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| $78, 571 per month.What do you need now
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| | Sales" * "Sales"Simplifying the Sales
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| to produce a 10% return on sales? You
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| | terms:(3) "Fixed Costs" = "Sales" times
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| need $33,000 / (1 - 0.58 - 0.10) =
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| | (1 - "Variable Cost % of Sales")Divide
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| $33,000 / 0.32 = $103,125.Calculating
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| | both sides of the equation by (1-
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| Breakeven in the Real WorldThere are a
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| | 'Variable Cost % of Sales")(4) "Fixed
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| few things you run into when you try to
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| | Costs" / (1 - ""Variable Cost % of
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| apply this technique in the real world.
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| | Sales") = "Sales"Which is the same as:(5)
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| Keep in mind that the numbers used to
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| | "Sales" = "Fixed Costs" / (1 - "Variable
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| calculate breakeven are coming from your
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| | Cost % of Sales")Profit Goal For a return
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| accounting system. Here's what you run
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| | on sales (ROS) of 10% (0.1), we want
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| into:Fixed costs seem to vary from month
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| | Profit to be 10% of sales. So now we
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| to monthGross profit margins and hence
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| | have:"Profit" = 0.1 * "Sales"But
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| variables costs may also vary from month
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| | also:"Profit" = Sales" - "Fixed Costs" -
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| to monthOwner compensation distorts the
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| | "Variable Cost % of Sales" *
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| breakeven calculationThe existence of
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| | "Sales"So:(1) 0.1 * "Sales" = "Sales" -
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| debt service makes a cash breakeven a
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| | "Fixed Costs" - "Variable Cost % of
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| better measureThe solution is to smooth
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| | Sales" * "Sales"To get all the Sales
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| out variations using moving averages, and
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| | terms on the same side of the equal
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| calculate more than one breakeven number
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| | sign:(2) "Fixed Costs" = "Sales" -
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| to find one that works best for your
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| | "Variable Cost % of Sales" * "Sales" -
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| situation.Fixed costs seem to vary from
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| | 0.1 * "Sales"Simplifying the Sales
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| month to monthThis seems like a
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| | terms:(3) "Fixed Costs" = "Sales" times
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| ridiculous statement. After all, what is
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| | (1 - "Variable Cost % of Sales" -
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| a fixed cost, but one that is "fixed."
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| | 0.1)Divide both sides of the equation by
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| Here are some reasons these numbers can
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| | (1- 'Variable Cost % of Sales" - 0.1)(4)
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| bounce around:1) the Bookkeeper may
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| | "Fixed Costs" / (1 - "Variable Cost % of
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| sometimes put an expense in the wrong
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| | Sales" - 0.1) = "Sales"Which is the same
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| month2) there may be other bookkeeping
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| | as:(5) "Sales" = "Fixed Costs" / (1 -
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| errors, especially if there is more than
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| | "Variable Cost % of Sales" - 0.1)(6)
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| one person making entries in the books.
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| | "Sales" = "Fixed Costs" / (1 - "Variable
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| What is booked as a cost of sales one
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| | Cost % of Sales" - "ROS %")Rusty Luhring
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| month may be a fixed expense another
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| | has spent the last 27 years as a software
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| month.3) some expenses are quarterly or
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| | entrepreneur. His first startup was
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| annual (such as business licenses)4) you
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| | Ferox Microsytems, Inc. where he
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| have unusual legal or accounting fees
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| | developed some of the first PC based
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| that are not related to the level of
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| | financial modeling software. The
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| salesGross profit margins may also vary
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| | software was used primarily by large
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| from month to monthThe mix of sales may
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| | corporations for financial analysis and
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| change from one month to the next,
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| | complicated planning models. Ferox grew
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| affecting your overall gross margin.
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| | rapidly in the early years, and then hit
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| Sales promotions may reduce average
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| | a few bumps and almost went under. The
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| prices. Tiered commission plans may cause
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| | experience of surviving some pretty
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| average commission rates to
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| | severe cash flow problems, and learning
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| fluctuate.Owner compensation distorts the
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| | to focus on the customer at the same
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| breakeven calculationOwner compensation
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| | time, inspired his second startup,
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| consists of owner salary and benefits,
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| | Luhring SurvivalWare, Inc. SurvivalWare
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| and possibly a few other expenses such as
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| | ( went online in 2002, dedicated to
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| the company delivery yacht or the
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| | helping small business survive and
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| European training seminars. Separating
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| | thrive. The SurvivalWare line of
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| out these expenses and calculating a
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| | software is designed to bring big company
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| breakeven on what is left helps you
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| | financial modeling and analysis to the
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| figure out what the number is you need to
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| | small business community by making it
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| make to keep the business running. The
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| | affordable, and spreading the development
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| theory is that in a pinch, you can give
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| | costs of a model over a large base of
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| up the perks and live on a mere mortal's
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| | customers. There is even a "Lite"
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| salary.The existence of debt service
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| | version (also known as Transaction
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| makes a cash breakeven a better
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| | Modeler) for those entrepreneurs who are
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| measureYou may or may not have a lot of
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| | in the middle of a cash flow crisis.
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| debt service. If you do have auto loans,
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| |
|
