BREAK-EVEN POINT: THE SECRET to SUCCESS
Business owners who do not know their break-even point will eventually find themselves asking,
“I’m making sales, but why don’t I have any money?”
How can this happen? The answer is simple – because you are probably not doing the math. Making sales is different than making a profit, and you cannot calculate accurate profit if you do not determine and use your break-even point as a key measure.
Many business owners may not fully know how to read their financials that directly feeds their cash flow. Just making sales does not guarantee solvency, you also need to make a profit.
Let’s look at how profit, loss, and break-even work.
If you earn $1.00 and have expenses of $.90, your profit is $.10. You have a profit margin of plus 10%. When your margin is positive, you are making a profit to provide your goods or services. Congratulations!
However, if you earn $1.00 and have expenses of $1.10, you lost $.10. You have a loss margin of minus 10%. When your margin is negative, you actually paying to provide your products to the customer.
And, if you earn $1.00 and have expenses of $1.00, then you are at break-even or zero. You have no profit or loss, you neither make nor lose money.
To understand the importance of knowing your break-even point look at this example. In 2014 ABC company had a net income (money they got to keep) of $500,000 from sales of $5 million, this is a profit margin of 10% ($500,000 divided by $5 million).
In 2015, they got a new customer. But, instead of doing a break-even analysis they estimated the costs and miscalculated the increased expenses (i.e., labor, supplies, overhead). They made the same profit of $500,000 again, only it was on sales of $5.5 million, resulting in a 9% margin.
They were making less money on a higher volume.
Then, in 2016, the same client offered ABC more business, which they accepted without running the break-even numbers. Because of increased expenses (i.e., new machinery, overtime, warehouse space) they produced the same net profit of $500,000. However, even though they had an additional one million in sales, a total of $6 million, their profit margin lowered to just an 8.3% profit.
Why? Their actual profit was flat. It stayed the same!
Let’s summarize. The company increased its volume by one million dollars over two years but made the same profit – which resulted in lowering its actual profit margin.
Math is non-negotiable – your product cannot cost more to make than what you charge for it. The only way to know how to make a profit is to figure out the break-even point. It can mean finally having enough money in your pocket to reinvest, scale your business, or even retire.
At Cogent Analytics, we never stop looking for ways to improve your profits.
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