When you’re planning a new business venture or looking to expand your current business by diversifying your offerings, it’s important to be able to gauge when your business can expect to become profitable. That way, you can estimate how long you need to cover expenses out of pocket until revenue reaches the level that it covers your expenses. The smallest minimum monthly profit you can strive for is $0. That’s the bare minimum profit you can take in where you revenues cover your expenses, dollar for dollar. When you reach $0 profit, you’ve found your business’ break-even point. So how do you calculate how many units you need to sell to reach this break-even point? There’s an easy formula that helps you calculate how much you need to sell.
Variable vs. Fixed Costs
Before you calculate your minimum monthly profit, you first need to identify your variable and fixed costs. Variable costs are the expenses that vary depending on the level of production. For example, labour for manufacturing employees and materials expenses are variable costs because you spend more on these expenses when you produce more. Fixed costs, on the other hand, are the costs that remain the same month to month, regardless of production levels. Lease payments on your production facility are a good example of this, because you pay the same monthly payment regardless of whether you produce one widget or 1,000.
Calculating the Break-Even Point
Once you identify your variable and fixed costs, you’re ready to calculate your minimum monthly profit. First, calculate the contribution margin, which is revenue per unit less variable expenses per unit. Assume your business sells a product for $24 and has variable expenses of $9 per unit. To calculate the contribution margin, you subtract $9 from $24 to get a $15 contribution margin per unit. Now divide your fixed costs by the contribution margin. Say your fixed expenses are $6,000. Divide $6,000 by $15 to get 400. This means you have to produce and sell 400 units to break even. If you sell 400 units, you earn $9,600 (400 x $24), which is enough to cover both your fixed costs of $6,000 and your variable costs of $3,600 (400 x $9).
Achieving Your Minimum Monthly Profit
So how do you reach your break-even point as quickly as possible? You’re probably eager to cross the profitability line, and the break-even formula helps you see what factors help you achieve this goal faster. If you lower your variable costs, your break-even point lowers. Consider streamlining your production processes so you need fewer labour hours to produce finished goods, or look for ways to cut costs on supplies. Fixed costs are not as easy to adjust, but you can consider the overall fixed costs when you make your business plans. While you may hope to have a massive production facility one day, it may make more sense to start with smaller accommodations early on until you reach profitably. It may make sense to raise prices at first to increase your contribution margin as well.
As you strive towards your minimum monthly profit level, it’s helpful to have up-to-date reports on your finances. Using an accounting system, such as QuickBooks Online, you can generate a Profit and Loss statement automatically. Learn how today.