In last weeks’ article, I discussed how to calculate the cost of creating your product, but it’s just as important for small business owners to know how to project your sales.
We begin first with a break even analysis. Working backwards through the formula for cost accounting will show how many cheesecakes you must create to break even--or if you have a service business, how many worker hours are required to break even.
Example: Using the cheesecake factory idea, fixed costs total $1,700.00 per month. Work backward through the equation to determine your break-even point - zero. In order to reach a profit of zero, how many cakes must you sell?
Manufacturing (Cheesecake) Break Even Point
$10.00 (sale price) 400 Cakes
5.00 (ingredients, direct labor)
$5.75 total variable costs
$4.25 gross profit per cake x 400 = $1,700.00 Gross profit
-1,700.00 Fixed costs
$ -0- Profit
If profit is zero and fixed costs are $1,700.00, then gross profit must be $1,700.00. Divide the gross profit of $1,700.00 by $4.25 (the gross profit per cake) and you get 400. If you sell less than 400 cakes in a month, you will not achieve sufficient gross profit to cover your fixed costs.
Multiply the quantity of 400 by the selling price of each cake - $10.00. Also, multiply the variable cost per cake by the quantity of 400. Let us examine the full equation:
Manufacturing (Cheesecake) Break even Point
Quantity = 1 Quantity = 400
$10.00 Sales $4,000.00
5.00 Ingredients, direct labor 2,000.00
.75 Packaging / stickers 300.00
$5.75 Total variable costs $2,300.00
$4.25 Gross profit $1,700.00 Gross profit
- $1,700.00 Fixed costs
$ -0- Profit
You want to do better than break even, so it’s time to project future profits. What is your goal? Let’s start with a profit of $2,550.00. Using that figure, calculate how many cakes you must sell. Work backward through the equation again. Add the $1,700.00 fixed cost figure to the projected profit of $2,550.00. You arrive at $4,250.00 gross profit. You already know that your gross profit per cake is $4.25. Divide $4,250.00 by the gross profit per cake to determine the projected quantity -- 4,250.00 ÷ 4.25 = 1,000. Extend sales and variable costs by multiplying the quantity by the sales price and variable costs per cake.
Quantity = 1 Quantity = 1,000
$10.00 Sales $10,000.00
5.00 ingredients/direct labor 5,000.00
.75 packaging/stickers 750.00
$5.75 total variable costs $ 5,750.00
$4.25 gross profit $ 4,250.00
-$ 1,700.00 fixed costs
=$ 2,550.00 profit
Once you have the idea, you can play with the numbers. Of course, you must take into consideration other factors, such as the capacity of the cheesecake factory. Perhaps the facilities need to be upgraded in order to produce as many cheesecakes as the projected profit dictates.
If you are a contractor, job costing begins before work actually starts. You must line up material and labor costs, cost of permits, blueprinting, design and all other costs associated with the project. Your fixed costs for the construction period should also be added as well as a percentage of overhead is figured in based on your average monthly administrative costs times the anticipated duration of the project. An additional figure is added for desired profit. When the project is complete, you should analyze the result. List out the actual expenses and compare them to your original estimate to determine the accuracy of your projections. Learn about yourself from your numbers. Were you too optimistic? Are you giving your work away? Or were you accurate in your projections? Did you allow room for error or did error eat up your profit margin? By constantly reviewing performance, we learn and perfect.
Using a computerized spreadsheet program will facilitate setting up the above equations. By assigning mathematical formulas to the appropriate cells, you can experiment with different scenarios.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all leveles Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitterat BLTaxpertise and at Facebook.