How to hit the Profit Zone
Navigating the choppy waters of running your own business can be a daunting task. Success is forged by understanding when you are on-course and heading in the right direction, and recognizing when your bottom line might be slipping away from you. Staying above the breakeven point is essential to keeping your business afloat. Therefore, it is essential that every business be able to understand and know how to determine their breakeven point: the sales amount where your business begins to make a profit.
Anyone reading this post got into business to make money, earn a profit and grow a business. Our reward comes when we manage the relationship between our sales and costs effectively to reach and exceed our breakeven point. Essentially, we are all striving to create situations where the difference between our sales and costs is a positive number.
Understanding profit and costs for distributors
Digging a little deeper, the breakeven point is technically where your fixed costs plus your variable costs equal your sales number. Fixed costs are all the costs that do not vary based on product volume. Examples of fixed costs include rent, phone, electricity and other general administrative costs in your business.
Alternatively, variable costs are costs that vary with the delivery of your products or services. These costs include labor, material, freight and other costs involved in delivering value. Adding your fixed and variable costs calculates your businesses total costs. Note that your total costs will always start at the level of your Fixed Costs, and increase per unit sold.
Sales revenue is all income from your units sold.
The breakeven point is the point where your total costs cross your sales revenue. Any sales above your breakeven point represent profit.
An Example Profit Calculation for Distributors
To make this concept even clearer, let’s apply this formula to an example distributor, who we’ll call Sample Company. Sample Company has the following data:
• $100,000 in sales
• $30,000 in cost of materials (“Material” in the statement below)
• $25,000 in labor added to the material to make the final product
• $5,000 in labor burden (production worker overhead of your business, such as unemployment taxes)
• Operating costs of $40,000 (these are fixed costs such as rent, utilities, non-production salaries, etc.)
In this example, the sales (or revenue) amount of $100,000 equals the total amount of expenses, meaning that Sample Company is currently at their breakeven point. They didn’t lose money, and they didn’t make money. Sample Company broke even.
You may also notice in our example, the gross margin is 40%. This meant for every dollar of sales of a product, $.40 is gross profit, and $.60 is needed to make the product. This is a useful number to benchmark your business with similar businesses, as well as for knowing the incremental sales needed to achieve a target profit.
With that in mind, let’s see how additional sales affect Sample Company’s bottom line:
As you can see, Sample Company needs sales of $350,000 to earn a profit of $100,000. This number can help management set sales goals, evaluate performance, or rethink processes.
Of course, your numbers will be different, but hopefully this example will move you towards a better understanding of your breakeven point and the sales needed to achieve a target profit level.
The cost and quality of your raw materials can have a major impact on your variable costs. Acadian Industrial Textiles strives to provide the highest-quality materials, at competitive prices. For more information on how Acadian can help your business succeed, view our products or contact your Acadian representative.
This article is based on a presentation by Ralph White, author of 12 Steps to Success in Business Life, business coach and entrepreneur. Many thanks to Ralph for sharing his business knowledge with us. For more from Ralph, visit his website.