One of the most fundamental but often times least understood financial principles of business operation is the concept of the break even point. Simply stated, the break even point is the point where your sales equal your expenses. Once you have achieved your break even point, then you should be making a profit on each additional product sold.
Let’s take a simple example. Let’s assume that we have fixed costs as follows:
Total Fixed Expenses= $2000/month
Let’s assume that we sell a widget that costs us $2 each to manufacture. We sell the widget for $7/ each, making us a profit of $5/widget. How many widgets must we sell before we reach break even?
Well, the answer is 400! How did we get that? Well, we know our fixed expenses are $2000. We make $5/widget, so we divide our total fixed expenses ($2000) by the profit contribution of each widget ($5) to get 400 widgets. We check our work, $ 5 X 400= $2000!!!
So, we must sell 400 widgets before we begin making any profit for the month, assuming our production schedule is calculated in months. Let’s keep this simple– we can add a whole plethora of wrinkles to this, however, for our example we now know that we have to sell 400 widgets before we make a profit. If we can make 50 widgets a day, then it will take us 8 days before we begin making any profit.
Now, if the widgets do not sell as rapidly as we predicted, it may take us longer in the month before we “turn a profit.” This is why it is very important to know your break even point– you know how much you have to sell before you are making money. Of course, we would not want to continue making widgets every day, building a large inventory if the product is not selling– that is the theme of another full article!
Calculate your break even point– when you know that, you then know what you have to do before you begin making a profit. After all, is that not we are in business for, to make a profit?