Business owners who do not know their break-even point will eventually find themselves asking,
“I’m making money, so how come I don’t have any?”
The answer for most owners is simple – because you are not doing the math. Making money is not making a profit, and you cannot make a profit if you do not know your break-even point. A lot of business owners do not understand how to read their financials or use them as a management tool. These are usually the same people who ask the above question. Just bringing in money does not guarantee solvency, you also need to make a profit on the money.
Let’s look at how profit, loss, and break-even works.
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 getting paid to provide your goods or services. If you earn $1.00 and have expenses of $1.10, your loss is $.10. You have a loss margin of minus 10%. When your margin is negative, you are paying for providing your products to the customer. If you earn $1.00 and have expenses of $1.00, you are at break-even or zero. You have no profit or loss, neither making nor losing 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 $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. In 2016 the client offered ABC more business, which they accepted without running the break-even numbers. Increased expenses (i.e., new machinery, overtime, warehouse space) produced the same net income of $500,000. Only it was on $6 million, which was an 8.3% profit. The company increased its volume by a million dollars over two years but made less profit. The owner could not understand why he had a smaller bonus in 2016 than he had in 2014, especially when he was working longer, more difficult hours. 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. So, in spite of what you thought, you do need some of your high school math in the real world. It can mean finally having enough money in your pocket.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information: