Have you ever gotten excited about the revenue your business is generating … only to have the crushing realization that despite your hustle, you’re still haven’t hit break even with your sales?
It’s frustrating when you pour your heart and soul into your business, yet witness your expenses outpace your revenue by a significant ratio month after month. You may feel like your business is bleeding money, but you have no idea how to staunch the flow, much less turn a profit.
This article will show you how to calculate your break even sales figure, as well as tips to reach this important number more quickly.
What Is “Break Even”?
Your break even sales figure is the minimum amount of revenue you need to generate to cover your operating expenses. When you hit this critical point, you haven’t generated a profit yet, but you haven’t suffered a loss.
But let’s be honest. Your goal as a business owner isn’t to break even. It’s to generate a big profit! Knowing your break even sales figure is the start.
Avoid This Break Even Calculation Mistake
As virtual Chief Financial Officers, the most common mistake we see business owners make when calculating their break even sales figure is thinking that every dollar of revenue can be used to cover operating expenses. For example, if they have $50,000 in monthly operating expenses, they believe they need to generate $50,000 in revenue to break even.
This is incorrect. Your break even sales figure depends on the gross profit generated from those sales.
You see, not every cent of every dollar you make is profit. You spend money to produce the goods and services you sell. Gross profit is what’s left after paying those expenses.
Let’s say that your gross profit percentage is 40 percent. This means that for every dollar of revenue you generate, 60 percent covers the cost of producing the products and/or services you’re selling, leaving a 40 percent gross profit. The gross profit is what is then used to cover your operating expenses.
To identify the sales figure you need to hit each month to produce enough profit to cover your operating expenses, divide your operating expenses by the Gross Profit Percentage.
Let’s go back to our example of having $50,000 in monthly operating expenses and a 40 percent gross profit margin. We’ll divide $50,000 by 40 percent (0.40), which equals $125,000. In other words, only when you hit $125,000 in sales will you have the $50,000 in Gross Profit needed to cover your operating expenses. That’s when you’ll hit break even; your Net Profit will still be $0.
Contrast that with the common misconception that break even means covering your operating expenses. If that were your belief, you’d think that $50,000 in revenue was your goal – which is significantly less than $125,000!
Use Your Break Even to Stay on Course
Knowing your monthly break even sales figure and using it to guide your efforts is an easy way to end your year in a healthy financial position.
Using only an annual goal makes it harder to tell if you’re on track to achieve your revenue target. Breaking an annual target into a monthly revenue goals makes it easier to tell when revenue is too low and gives time for a course correction.
Tracking a monthly target also makes it harder to dismiss poor performance. With an annual goal, you can fool yourself into believing that you’ll get caught up. With a monthly goal, you’re looking at the cold, hard facts on a much more regular basis.
Use Your Break Even to Guide Negotiations
When negotiating sales, particularly big deals, you may be tempted to offer discounts or agree to a prospective customer’s request to flex your pricing schedule.
You may think that making concessions is okay because it generates revenue. But will your concessions cost you in the long run, hurting more than helping?
But calculating your monthly break even sales figure, you’ll know whether agreeing to concessions will help your bottom line. If you’ve already met your break even, you can afford to make the deal. But if you haven’t, you’ll need to stick to your standard pricing schedule.
Use Break Even to Design Your Profit
The break even sales figure, by its very definition, assumes no profit. But generating a profit is a primary goal of running a business. The answer is to plan for a profit and build it into your calculation of your break even sales figure.
Here’s how to design your profit:
- Identify how much of a profit – as a percentage – you want to generate.
- Subtract the desired Net Profit Percentage from the Gross Profit Percentage.
- Divide the operating expenses by the new (reduced) level of Gross Profit. You now know what monthly revenue figure you need to hit to ensure the level of net profitability you want.
Let’s use our example from above. Let’s say you want a 15 percent Net Profit. This means reducing the Gross Profit Percentage from 40 percent to 25 percent. Dividing our operating expenses of $50,000 by 25 percent reveals that our monthly sales target is now $200,000, up from the break-even sales figure of $125,000.
What to Do If You Aren’t Hitting Break Even
Now that you know the correct way to calculate your break even sales figure, you may be dismayed – and even slightly panicked – to realize that you are nowhere close to hitting this key number each month.
Take a breath – and then celebrate. Yes, celebrate! You’ve just discovered the reason why you’re working so hard, yet coming up short at the end of each year. Now that you know where the problem is, you can take corrective action.
- Start by reviewing expenses related to producing your goods and/or services. Reducing your costs will boost your Gross Profit.
- Likewise, consider whether you can raise the price of your goods and/or services. This also will increase your Gross Profit.
- Next, look at your operating expenses. Can you reduce them in any way?
All three of these steps will reduce your break even sales figure. Once you’ve reduced this number as much as possible, it’s time to focus on ramping up your sales.
Break Even … a Top Number to Know
Knowing your break even sales figure is one of the most valuable pieces of information you can use to grow and scale your business. It will help you stop giving away dangerous discounts, ensure that your hard work pays off, and give you peace of mind knowing that your business is on course to hit the profitability targets you set.
If you’d like help identifying your break even sales figure and ways to hit your target month after month, schedule a free, no-obligation Strategies & Solutions Session here.
