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However, for businesses who provide a mix of direct services/labour and materials, the above type of calculation method is not always appropriate. A different methodology is required to get to the correct outcome: some well-researched assumptions plus consideration of the recent past performances of the business.
One such method is to take an average of the past two or three years Gross Profit, expressed as a percentage of total Sales, and use this in your calculation. For example, if your annual Fixed Costs are $100,000 and your average Gross Profit is 40% of total Sales, then you simply divide $100,000 by 40% to arrive at a required breakeven Sales amount of $250,000.
The key to calculating this successfully is to as accurately as possible work out the true variable costs (those costs which are incorporated into what is being sold to your customer) versus the true fixed costs, which are typically static in nature and not directly incorporated into the product or service being sold.
Typical examples of these two categories of costs are:
The measurement of this number can be more easily calculated due to the way Profit and Loss Statements in business management accounts are compiled. This is done by carefully selecting all the true cost items of production and placing them under the section called the ‘Cost of Goods Sold’ or ‘Cost of Sales’. This determines the correct Gross Profit of the business and as stated above, when expressed as a percentage of Sales it becomes the key metric to working out your Breakeven Sales amount in dollars.
In order to more accurately calculate your Gross Profit you include the following cost items:
It’s often here where errors in assumptions can be made. Getting this right, however, allows you to more carefully and accurately determine not only your breakeven sales amount but also help work out the profit margin you need to make.
At BHR Papalia we have a team of very experienced and qualified accountants and business advisors who can assist you to better understand your business numbers, and find hidden opportunities to improve your bottom line.
Come and talk with us to find how far you can go with your business!