Break Even for Product Based Businesses

In a product business, you've got a more complicated calculation than service businesses. You probably know that, but the starting point for everyone is knowing how much money you need to pay your personal bills.

Starting off, looking at your home budget, how much money do you need to pay or contribute to the household costs? Rent, mortgage, fire, electricity, utilities. Internet, motor vehicles if they're not in the business, holidays, entertainment, food, that's an important one, and kid school fees, kids' clothing, extra curricular activities, holidays. Everything that you would normally spend at home, you need to work out what that is. If that's split amongst different members of the family, what your contribution needs to be for that.

If you're already drawing a particular set amount out of your business as a salary wage or drawings, depending on your business structure, that's great. But just double check that you have got the right number for the purposes of your household, and you're not going backwards on that because you need to look after number one first.

You need to look after your personal needs. Then you can look after your business needs.

As business owners, we often do it the other way around but we do need to make sure the home bills are being paid. The next thing I said was to pull out the profit and loss statement from your accounting system, preferably the last 12 months.

If you need to, if your system allows you to do, pick up that 12 months, great. If you need to go back from last month to end of last financial year and then the rest of the 12 months in the financial year figures, do that then do that. But we need to get 12 months because we want make sure that we don't miss any of the annual costs that come through. Have a good detailed look at those expenses, identifying that isn't continuing, identify how much of an inflation uplift you may have to apply to some. If there are expenses that you're going to spend more on and you know that already, then what those numbers are. We want to work out what the total per annum is, so total annual costs to keep the doors open, to keep everything happening.

Now, I want you then to put that number aside for now. Then I want to look at your sales and cost of sales.

In a product-based business, you know you have to buy your product.

You've got freight. You've got possibly import duties and costs associated with bringing the goods into the country, if that's what you have to do. Packaging costs potentially, if you're putting multiple pieces together, potentially some costing in manufacturing or creating a product, all those. You may also, if you're online and you're doing deliveries, you may have a delivery component. If your delivery component is included in your sales price, either you don't charge extra for delivery, then that's part of your cost of sale.

If whatever delivery charges, you do charge your customer for that. Then you can ignore the delivery cost to customer because they're paying for it. That's a coming in and out as long as that is the case. I'm simplifying a little bit because I can't cover every detail in this. What you then have is the cost of purchase of product, import costs, freight costs, your packaging costs. Those things that get you your total cost of your product that you're selling. Then, of course, you know you've got your sell price. Most product businesses have thousands of lines in them. For the purpose of this, we're going to add them all up together. As long as you assume that the rough mix of different product sales will continue and work vastly change, then we can calculate your gross margin.

Your gross margin is calculated by taking the total income, total costs of sale.

Those product costs, freight delivery import costs, packaging costs, all of that, take that number off your sales number and you've got your gross profit. To calculate gross margin, you take that number and divide it by your sales number. Apply and calculate that as a percentage. One of the areas that I find some people get very mixed up on these, they say, "Oh, I've got 100% margin," but they actually don't. What they're selling is that it costs them $5. They're selling for $10 so they've made 100% markup. But a markup is not margin, different numbers start with M but confusing.

Markup is what percentage, often it's a percentage, that you add to your costs to determine your sale price.

Use my example again $5 cost, $10 price. You've done 100% markup. Yep, fair enough. But the reality is if you sell fo $10, you've got costs of $5, you've made a $5 gross profit. Your gross margin is $5 gross profit divided by $10 sales, which gives you a gross margin of 50%. Just be very wary that you're not thinking of your markup. It's the amount, the net your gross profit as a percentage of sales. I want you to take that and look at if you've got seasonality, and then you may need to fiddle around with that a little bit. But have a look at, on average over the last 12 months, what is your gross margin percentage. Using my example there, gross margin percentage of 50%, it might be easy to move forward on this calculation.

Go back now to your total expenses. There's all the other expenses; the wages, the rent, everything else that you need to spend to keep the doors open and promote and do what you do. Unless for the purpose of more calculation minutes, say your total expense is completely unrealistic. My total expenses are $100000 for 12 months. If you've run a retail business, my guess is that you'll be up in 52 weeks of the year. You've got an online product business, you'll be open 52 weeks of the year. One of the differences between this and the service-based business that I talked about previously, is your costs should be being recovered weekly, every week of the year for 52 weeks.

If, however, you do shut down for a couple of weeks then what I would do is take your total expenses, that 100000 I've just saved, and divide it by the number of weeks that you are open for business. Then, we'll start talking about a weekly number. If we work on 52 weeks, I've got $100000 of expense and I'll have a gross margin percentage of 50%. What that means is that I would need to be selling $200000 worth of product in order to make $100000 of gross profit, which will cover my $100000 of expenses and give me a zero profit, zero loss, breakeven. But it's not just about breaking even. It's about making profit.

Your breakeven is your baseline. You really do need to be looking at setting a target goal that is greater than that to make a profit level, and one that's a bit of a stretch goal that you'd like to achieve if you possibly could.

You may need to keep these numbers as accumulating numbers because you may find that your sales revenue is a bit cyclical, a bit seasonal, maybe some weeks better than the other, some months better than others. You may need to be keeping this as an accumulating number so that you can identify how you're tracking a rollover an extended period of time. The key is then that it's designed to take some stress off your shoulders, to make you feel more confident about how the business is going.

I challenge you to take some time. Put aside an hour maybe to pull out the profit and loss from your accounting system. Have a good hard look at those expenses.

Work out your gross margin percentage, identify what your breakeven number is, and start to track it. See whether you don't get the benefit that I found doing it myself, that my clients are saying they found when we've worked on this with my clients exactly the same thing. See when you're not feeling better about how your business is going and feeling more confident about where the business is going, and the profits you're going to make.

Don't forget. If your numbers change, if there's an increase in your costs, you need to reset that breakeven number. Go ahead. Give it a go. Give it a try, and see how you feel about your business and the numbers.