THE DR. IS IN : Breakeven Diagnosed!

Understand your numbers and make educated business decisions.

Knowing your numbers is the difference between making profit happen or just happening to make profit. Electronic systems contractors (ESCs) who understand their numbers use those numbers to make management decisions such as pricing and staffing.

Those who do not understand numbers are accidents waiting to happen; sometimes they accidentally make a profit and sometimes they accidentally lose money! And if they accidentally make a profit more often then not, they stay in business. But in today's economy, it's not so easy to accidentally make a profit. It appears to be much easier to accidentally lose money, and sooner or later, the business can't survive.

In the June issue, I discussed the difference between markup and margin. Remember that margin is always calculated as a percentage of sales price. Using your margin to create a sales price is an important part of the sales process. Reviewing your financials is an important part of the management process. While your proposals contain an anticipated margin, your financials can show you your achieved margin.

Once you determine the margin you are able to achieve, you can then use that number to create a breakeven analysis. A breakeven analysis is simply a numbers game that relates the gross margin to sales, overhead and profit. It is an excellent tool that can help you answer the "what if" questions: What if I hire another project manager? What if my sales volume changes? Should I invest in more marketing?

Breakeven example for increased overhead

For example, let's say that you are considering investing $7,000 in a new marketing campaign. Should you do it? To answer that, you might consider a breakeven analysis.

First, let's look at the current financial statement:

Profit & Loss Statement

Sales 300,000 100%

COGS 195,000

Gross Profit 105,000 35%

Overhead 75,000 25%

Net Profit 30,000 10%

In this example, we've achieved a 35 percent margin. Now, you can use that number to help you make this decision. The formula we will use is Gross Profit divided by Gross Margin equals sales:

Gross Profit Gross Margin Sales

$105,000 ÷ 35% = $300,000

Next, let's add the $7,000 for our new marketing campaign into our overhead. This means that our new overhead number is $82,000. Technically, a breakeven company makes no profit—but for our purposes, we will include the profit as well. Therefore, if we want to maintain the same profit ($30,000), and increase our overhead by $7,000, we need to earn a Gross Profit of $112,000. Using that same formula we can determine the sales we need to justify the marketing dollars and maintain our profit.