One Measure You Must Know For Your Business
Lately, everyone (including the author on a regular basis) has been talking about business intelligence, financial analysis, and gaining insights from your data. It’s absolutely true; in order to have a successful business, we need to be able to understand the data and evaluate our results. We need to measure and analyze. But it is easy to overcomplicate things by trying to figure out exactly what to measure, which reports to run, and which transactions to view in that Pivot Table of yours. So let’s take a step back for a moment and go back to basics.
Rather than getting lost in the madness of measuring everything under the sun, why not start with one key measure. Once you master this, you can move on to other more exciting and hard to explain measures. But this one is pretty important.
Break-even point
The break-even point is defined as the number of units you must sell in order to cover your fixed costs of the business.
Before you start working the calculator, you need to gather some information:
Gross profit per unit in dollars. Calculate the difference between your product sales price and the cost of the item sold. Ideally, determine the gross profit for individual items and then calculate the average profit across each item you sell. Use the average gross profit in the equation below. The costs of each item sold are called variable costs, which rise (in terms of total dollars) with increasing unit sales. (If you don’t know the cost per unit, you need to fix that before you do anything else.)
Fixed expenses (often operating expenses like rent and utilities) in dollars. These are the costs you incur running your business, whether you sell a single unit or not. Include costs like rent, utilities, accounting fees, and marketing.
Once you know the top two figures, the formula for calculating your break-even point is:
Fixed Costs / Gross Profit per Unit* = Number of units to break even
If your fixed cost of the business is $5,000 per month and you make $100 of profit on each unit you sell, your break- even point for the month is 50 units. You cannot cover the operating costs of the business unless you sell at least 51 units each month.
Everyone on your team needs to know what this number is and how to calculate it. As per unit profits change, adjust the break-even number of units accordingly.
How to apply the measure
Calculating sales commissions and bonuses. If you are paying sales commissions to your team, you should not start the bonus until sales exceed the break- even point. So in our example, as soon as your sales team sells more than 50 units, a bonus percentage should kick in for the team. Never pay bonuses on sales below your break- even point, as you will effectively be adding to the fixed costs of your business.
Evaluate new products. If you are seeking to add new products to your line, compare incremental fixed costs like new product design and collateral development for each item with the expected profit per unit you produce. Product with the lowest break-even point should be your top priority.
Start with break-even and go from there. By keeping your eye on the break-even point in your business, you can avoid making decisions that negatively impact your bottom line.
*also known as Product Contribution Margin