Forecasting profits is an important exercise for any business. A forecast of future profits may win over hesitant investors and also helps you plan for business expansion. This is especially true in Asia, where investors are more risk averse. A cost volume profit analysis incorporates fixed costs, variable costs, sales price, and sales quantity to predict your net profit as certain variables change.
Fixed and Variable Costs
To project your profits, you first need to understand how costs behave at different sales levels. Some costs, like your salary, leases, property taxes, administrative expenses, and professional fees, don’t tend to change. Others, like your inventory costs, sales commissions, packaging, and shipping costs, directly vary based on sales. Identify all of your variable monthly costs and divide them by your monthly unit sales to find variable costs per unit.
Account for Changes in Fixed Costs
Fixed costs are fixed — to a point. As sales increase, the overall cost of doing business eventually increases. This means that some fixed costs — like rent, utilities, accounting fees, customer service and office staff salaries, and the base portion of sales salaries — all have the potential to go up.
To estimate profits at higher sales levels, you need to account for these increasing costs. At certain intervals in your forecast — for instance, each time your sales grow by 50 percent — reevaluate the fixed cost figure and adjust it as necessary.
Your net profit is sales minus variable and fixed expenses. As a formula, it looks like this:
Net profit = (price per unit x units sold) – (variable costs per unit x units sold) – fixed costs
For example, if your variable costs are $30 per unit, fixed costs are $10,000 a month and your product is priced at $100 per unit. If you sell 500 units a month, your profit is $50,000 less $15,000 less $10,000 for a net profit of $25,000. If you sell 750 units a month, your profit is $75,000 less $22,500 less $10,000 for a net profit of $42,500.
Calculate Your Break-Even Point
If you’re worried that your business may experience some slow months, you can switch a few numbers around and calculate your business’s break-even point, the minimum number of units you need to sell to cover your costs. To calculate break-even, set profit to zero and solve for units sold. In a formula format, break-even equals fixed costs divided by price per unit less variable cost per unit. In the above example, break-even is at $10,000 divided by $70, or 143 units.
Play With Prices and Quantities
Cost volume profit analysis can also tell you how a price change might affect your profits. Under the basic rules of supply and demand, you’ll sell more products at a lower price point and less at a higher price point. If you have an idea of how elastic the demand for your product is, you can plug in new numbers for price and sales quantity to project your profits. For example, instead of selling 500 units a month at $100 each, you may be able to sell 400 units a month at $125 each with the same fixed costs and variable costs per unit. Even though gross revenue is the same in either scenario, net income would increase by $3,000.