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Measure your breakeven sales level each month. What are breakeven sales you ask and why should I care? Breakeven sales are the sales level where the gross profit on your shipments equals all of your fixed costs for the month. You can think of it as the sales level where you are breakeven; the current company sales level where you make no money and you lose no money. If your firm had breakeven sales for the month, your profit and loss statement (P&L) will show zero for net profit (bottom line).
Does your breakeven sales level change? Yes, every time there are any of these changes:
- Fixed Cost Change: Rise or drop in fixed costs (i.e. layoffs in accounting or sales, less office supplies purchased, abnormally high sales literature expense, telephone bill drops, successful fight over assessed property taxes results in a lower property tax bill for the year, lawyers’ fees increase, sales travel and entertainment increases over prior months’ levels,
- Product Mix Change: Every time the mix of product sold changes (i.e. more high gross profit margin items sell compared to previous months or there is a drop in lower margin business resulting in an overall weighted gross profit percentage rise).
- Change in Sales: When sales dollars over a monthly period drop or rise compared to previous months’ performances.
BES is normally measured monthly and its trend is more relevant than one month of data. As breakeven sales rise, this means either your fixed costs are rising (someone is spending more money than normal levels), or your gross profit is dropping (prices are being cut possibly), high margin customers maybe dropping off, low margin sales are being added or a number of other variables. It is important to measure the trend of this ratio (BES) to watch where you company is going so you can take actions to correct negative trends that could ultimately cut into your bottom line.
Example:
Fixed costs/ (1 minus COGS %) = breakeven sales (BES) or Fixed Costs/ Gross Profit %
$ 425,000 / (1 – .73) = BES (breakeven sales)
$ 425,000 / .27 = $1.574.074.
In summary, for $425,000 of fixed costs and incremental cost of goods sold (COGS) of 73%, breakeven sales occur at $1,574,074. That means the company must earn more than this to start to earn a profit.
