Is Your Business Profitable?

July 16, 2019 by OSYB Staff

You have done it, started your own business. Now, comes the hard part, doing something that you love and making a profit. How do you measure your small business profitability? Intuit Quickbook shares a tool to measure your profitability, break-even analysis. Break-even analysis helps to set the selling price of your products. This calculation helps to figure out the point at which your fixed and variable costs become equal to your total revenue. This calculation reveals the number of units you need to sell to balance the books.

Here are some factors to familiarize yourself with to work on the calculation:

1. Fixed costs – business expenses that remain the same or vary slightly every month and could include rent, property taxes, payroll, insurance premiums, and utilities
2. Variable costs – business expenses that fluctuate up or down,and are directly dependent on the level of production or number of units you make each month and could include raw materials, direct labor costs,
   product shipping costs, and sales commissions
3. Price per unit – setting the price of each unit is the one factor that will help determine your profitability and the only factor that you have direct control over. When setting the ‘right price’ make sure you have a thorough understanding of what your competition is charging for the same product, which price range you want to be at – low, middle or high, and what is your cost for the unit, and what level of profit do you want to make.
4. Revenue – is simply the money you earn through the sale of your product or service during a specified period. Calculate it by multiplying the number of units sold by the cost per unit.
5. Contribution margin – informs you as to how much each unit sold contributes toward your total revenue. Calculated by subtracting your variable expenses from your overall sales revenue. The formula is: Unit contribution margin = unit selling price – variable costs
6. Contribution margin ratio – is the contribution margin expressed in terms of a percentage of the unit price. The contribution margin tells you the specific dollar amount that each unit contributes to your profit, while the contribution margin ratio tells you the percentage amount that product contributes to your overall profit. The formula is: Contribution margin ratio = contribution margin per unit ÷ price per unit

Now that you have the variables required to determine your break even analysis, here’s how to calculate it. Either, “determine your break even point by calculating the number of units you’ll need to sell to cover both your fixed and variable costs, or you can calculate the dollar amount of revenue you’ll need to generate to cover expenses. “

To calculate your break even point using how many units you’ll need to sell, your formula would be this: Break-even point in units = fixed costs ÷ contribution margin per unit

The result will tell you the exact number of units you’ll need to sell in order for your business to support itself.

If you choose to calculate your break even analysis by the amount of sales revenue you need to generate to break even, your formula would be this:
Break-even point in sales revenue = fixed costs ÷ contribution margin ratio

The result will tell you how much sales revenue you need to break even.

When you have determined your break even analysis you can adjust the prices to change the results. For example, if you want to sell less units to meet your break even analysis, you raise the price. Or, if you want your product to be accessible to more people, you can lower the price and sell more units. At this point, you can also increase your profit margins by finding ways to decrease your expenses per unit.

In conclusion, break even analysis uses “hard data to give you real answers about the future profitability of your business”. Use this tool as a part of your small business financial analysis:

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For the full article: Break even analysis: How to calculate your business’s profitability

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