Calculating Break-even for a Given Profit

C: We can find out what kind of sales B-E needed to make a profit using the formula again. Leaving the other figures the same, let's put in a modest profit - say, 9,000 - and see what sales they needed. The formula now looks like this:

Sales = Fixed Expenses + Variable Costs + Profit.

M: You just add the desired amount of profit in?

C: Yes, really it affects the break-even point just like a fixed expense:

S = 19,200 + .70S + 9,000 (desired profit)

10S = 192,000 + 7S + 90,000 (multiple by 10 to eliminate fraction)

3S = 282,000

S = 94,000

M: May I check the figures this time?

C: Certainly.

M: All right, let's see:

C: Convinced?

M: Yes, I can see how this formula can help you find how much you need to  sell to break even or make a given profit, but what about my problem?

Break-even Analysis for Planning

C: Break-even analysis is just what you need. It's primarily a planning tool. I've looked at your Income Statement and divided it into fixed and variable costs. As I see it, your cost of sales, which we'll consider as your total variable costs, comes to about 60 percent of sales. Your fixed expenses ran about 60,000. So for last year:

S = 60,000 + .60S

10S = 600,000 + 6S

4S = 600,000

S= 150,000

You had to sell only 150,000 worth of merchandise to break even.

M: As you can see, I sold 200,000 worth, but I didn't make a 50,000  profit.

C: Right, you made a 20,000 profit just as the bottom line indicates. Remember, you still had those variable costs on sales even after all of your fixed expenses were covered at the 150,000 level.

M: Oh, I see, it's like this:

S = F + V + Profit

S = 60,000 + .60S = 20,000

10S = 600,000 + 6S + 200,000

4S = 800,000

S = 200,000

C: Now you've got it. Let's consider your expansion question. How much will  your rent increase?

Using Break-even Analysis to Examine Expansion Feasibility

M: It would be about 5,000 more. I figure the utilities for the larger space will be 2,000 more than I paid last year. Taxes, the "fixed" ones, I expect to run about 500, I also think I may need to hire another sales person.

C: Let's say you do. What do you plan to pay?

M: I'd pay an experienced sales clerk about 9,000. I'm toying with the  idea of instituting a 2 percent commission on sales as an incentive,too.

C: All right. We know it's not as simple as we'll lay it out, but I think  the analysis will give you an idea of whether or not to explore the  expansion idea more carefully and in greater detail.

M: Fine

C: Your fixed expenses will rise by 17,500, if you include hiring another employee. That brings them to 77,500, assuming no other increases from last year's 60,000. For simplicity's sake let's assume your cost of sales (your variable costs) will increase only by the 2 percent commission. That means 62 percent of sales for variable costs. so:

S = 77,500 + .62S

100S = 7,774,000 + 62S (multiplied by 100 to eliminate fraction)

38S = 7,775,000

S = 205,000 (approximately)

M: Only 5,000 more than I did last year? I can do that easily.

C: And be 20,000 in profits worse off than last year. Let's put last year's 20,000 profit in - in an expansion you still might want to do at least as well:

S = 77,500 + .62S + 22,000

100S = 7,750,000 + 62S + 2,000,000

38S = 9,750,000

S = 257,000 (approximately)

M: Hm, that's approximately a 25 percent sales increase just to make the  same profit as last year.

Business Judgment Still Necessary

C: Do you think you can boost sales by that much? Perhaps you see long range benefits from expansion that justify sacrificing some profit for
the short run.

M: I'm not sure. I'll have to give it more thought, look at the trends in my business and in this area. My pricing policy may need adjustment. Maybe I can cut costs. But now at least I've got a starting point, a dollar figure I can work with and from. Most importantly of all, I have a technique to help me attack my problem and help point me toward a rational decision.

C: That's what break-even analysis is all about.

Pricing Policies

A word of caution is in order regarding the popular but misunderstood pricing method known as retailers mark-up. Retail mark-up means the amount added to the price of an item to arrive at the retail sales price, either in dollars or as a percentage of the cost.

For example, if a single item costing $8.00 is sold for $12.00 it carries a mark-up of $4.00 or 50 percent. If a group of items costing $6,000 is offered for $10,000, the mark-up is $4,000 or 66.33 percent. While in these illustrations the mark-up percentage appears generally to equal the gross margin percentages, the mark-up is not the same as the gross margin. Adding mark-up to the price merely to simplify pricing will almost always adversely affect profitability.

To demonstrate, assume a manager determines from past records that the business's operating expenses average 29 percent of sales. She decides that she is entitled to a profit of 3 percent. So she prices her goods at a 32 percent gross margin, in order to earn a 3 percent profit after all operating expenses are paid. What she fails to realize, however, is that once the goods are displayed, some may be lost through pilferage. Others may have to be marked down later in order to sell them, or employees may purchase some of them at a discount. Therefore, the total reductions (mark-downs, shortages, discounts) in the sales price realized from selling all the inventory actually add up to an annual average of six percent of total sales. To correctly calculate the necessary mark-up required to yield a 32 percent gross margin, these reductions to inventory must be anticipated and added into its selling price. Using the formula:

To obtain the desired gross margin of 32 percent, therefore, the retailer must initially mark up his inventory by nearly 36 percent.

Pricing Policies and Profitability Goals

Break-Even Analysis and Return on Investment, discussed earlier in this section,  should be reviewed at this time. Remember, all costs (direct and indirect), the break-even point, desired profit, and the methods of calculating sales price from these factors must be thoroughly studied when you establish pricing policies and profitability goals. They should be understood before you offer items for sale because an omission or error in these calculations could make the difference between success and failure.

Selling Strategy

Proper product pricing is only one facet of overall planning for profitability. A second major factor to be determined once costs, break-even point, and profitability goals have been analyzed, is the selling strategy. Three sales planning approaches are used (often concurrently) by businesses to develop final pricing policies, as they strive to compete successfully.

In the first, employed as a short-term strategy in the earliest stages of a business, the owner/manager sells products at such low prices that the business only breaks even (no profit), while trying to attract future steady customers. As volume grows, the owner/manager gradually builds in the profit margin necessary to achieve the targeted Return on Investment.

 

 

Evaluate your budget periodically with actual operations figures. With effective records you can accomplish this. Then, where
discrepancies show up it is possible to take corrective action before it is too late. The proper decisions for the ideal
corrective action will depend upon your understanding of management techniques in purchasing, pricing, selling, selecting and
training staff, and handling other management issues.

You're thinking you are able to hire a bookkeeper or an Accountant to handle the record keeping for you. Yes, you can. But
remember two very important facts:

1. Provide the accountant with true input. If you buy something And do not record the sum in your business checkbook, the
accountant can not enter it. Should you sell something for money and don't record it, then the accountant won't understand about
it. The records the accountant prepares will probably be no greater than the info that you provide.

2. Utilize the documents to make decisions. If you moved to a physician And he told you you were sick and needed certain
medication to get well, you would follow his guidance. Should you pay an accountant and he tells you that your earnings are down
this year, do not hide your head in the sand and pretend the issue will go off. It won't.

Business Management Roll in Personnel Selection. If your Small Business Will be big enough to require outside help, a significant
duty will be the choice and training of one or more workers. You may start out with relatives or business partners that will
assist you. But when the business grows - as you hope it will - that the time will come when you have to select and train
employees.

Careful choice of employees is vital. To select the right Employees determine beforehand what you need each one to do.

Then search for applicants to fill these specific needs. In a small Business you may need flexible employees who can shift from
task to task as required. Include this in the outline of those tasks you would like to fill. At precisely the exact same time,
look ahead and organize your hiring to assure an organization of individuals capable of accomplishing every crucial role. In a
retail store, a salesperson might also do stock-keeping or bookkeeping at the outset, but as the business grows you'll need sales
people, stock-keepers and bookkeepers.

Once the job descriptions are written, line up applicants from whom To make a selection. Don't be swayed by clients who might
suggest relatives. In the event the candidate doesn't succeed, you might lose a customer in addition to a worker. Some sources of
potential new employees are:

1. Tips by friends, business acquaintances. 2. Employment agencies. 3. Placement agencies of top schools, business schools, and
colleges. 4. Trade and industrial institutions. 5. Help-wanted advertisements in local newspapers.

Your next job is to display want ad responses and/or program Forms sent by employment agencies. Some applicants will be eliminated
sight unseen. For every one of those others, the application form or letter will act as a foundation for the interview that ought
to be conducted privately. Put the applicant at ease by describing your company generally and the job in particular. As soon as
you have completed this, invite the applicant to speak. Selecting the right person is very important. Ask your questions carefully
to learn everything about the applicant that's pertinent to the job.

References are crucial, and should be checked prior to making a final decision. Check through a personal visit or a phone call
directly to the applicant's immediate previous manager, whenever at all possible. Verify that the information given you is
correct. Consider, with judgment, any negative remarks you hear and what is not said.

Checking references can bring to light important information Which may help save you money and future inconvenience.

Personnel Training. A well-selected employee is only a potential Asset to your organization. Whether or not he or she becomes a
true advantage is dependent upon your own training. Remember:

To allow sufficient time for instruction. Not to expect too much from The trainee in too short a time. To let the worker learn by
doing under real working conditions, with close oversight. To follow along with your training.

Examine the worker's performance after he or she has been in work For a time. Re-explain important points and short cuts; bring
the employee up to date on new developments and encourage inquiries. Training is a continuous process which becomes excruciating
oversight.

Personnel Supervision. Supervision is the third crucial of personnel control. Fantastic oversight will lessen the cost of
operating your company by cutting down on the amount of employee mistakes. When mistakes are corrected early, employees will find
more satisfaction from their jobs and perform better.

Motivating Employees. Small businesses sometimes face particular Problems in motivating employees. In a large company, a good
employee can see An chance to advance into management. In a small business, You're the management. One thing you Might Wish to
consider would be to give good employees a Small share of their proceeds, either via part-ownership or a profit-sharing plan.
Somebody Who has a"share of this action" will be more Concerned about helping to make a success of the business.

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