Q: I
understand how a one-product company calculates its breakeven
point, but how is the calculation done when you sell multiple
products? My firm sells two products, chairs and bar stools, for
$50 per unit. The variable costs are $25 for each chair and $20 for
each bar stool. Fixed costs for the firm are $20,000 per month. If
the sales mix is 1:1 (one chair sold for every bar stool sold),
what is the breakeven point in dollars of sales and in units of
chairs and bar stools?
A: In
a previous article,
I described this simple formula for calculating the breakeven
point: breakeven = fixed costs /gross margin percentage, where
fixed costs are recurring monthly expenses that do not vary with
sales (such as rent, salaries and so on) and gross margin
percentage of a product means its profit divided by its price.
That simple calculation assumed a one-product company;
therefore, it was easy and straightforward to determine the gross
margin of a particular product. However, the calculation gets a
little more complex when you throw additional products into the
mix. The answer to your question lies in the calculation for
computing the gross margin for multiple products. The breakeven
calculation itself does not change.
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Instead of using the simple gross margin percentage, you must
compute the "weighted average" gross margin percentage,
which is calculated as the sum of the gross margin percentage for
each product multiplied by its percentage of sales. Returning to
your example, the chair has a gross margin of 50 percent: (50-25)
/50. The stool has a gross margin of 60 percent: (50-20) /50. Each
product accounts for 50 percent of the unit sales of the firm
(meaning a 1:1 sales mix). Therefore, the weighted average gross
margin is:
- Chair: 50% x 50% = 25%
- Stool: 60% x 50% = 30%
- Weighted average gross margin = 55% (25% + 30%)
Then, you would use the weighted average percentage in the
breakeven formula as follows: breakeven = $20,000 /.55 = $36,363.
To calculate the unit sales of each product, take the breakeven
sales, multiply by the product's sales mix, and then divide by
its price as follows:
- Stools to sell = $36,363 x 50% /$50 = 363 stools
- Chairs to sell = $36,363 x 50% /$50 = 363 chairs
From the above example, we can see how changing the sales mix
can affect the breakeven point. For example, if the above firm were
to sell 70 percent stools and 30 percent chairs, the breakeven
point would be reduced to $35,088 because the weighted average
gross margin increased to 57 percent. Conversely, if the firm where
to sell 30 percent stools and 70 percent chairs, the breakeven
point would be increased to $37,736 because the weighted average
gross margin decreased to 53 percent.
Your goal as a business owner is to keep the breakeven point as
low as possible. Product price, product costs, product volume and
fixed cost all play a role in determining the breakeven point as
well as the ultimate success of any business.
Ian Benoliel is the CEO of NumberCruncher.com Inc., a
developer of budgeting, manufacturing and management software for
entrepreneurial businesses. NumberCruncher combines its accounting
and finance expertise with technological know-how to deliver
software that is affordable and easy to use, yet sophisticated and
powerful. More information on the NumberCruncher's products and
services is available at www.numbercruncher.com. Ian has nearly two
decades of business, accounting and financial consulting
experience. He has advised corporations on business plans,
financial projections and accounting computer systems.
The opinions expressed in this column are those
of the author, not of Entrepreneur.com. All answers are intended to
be general in nature, without regard to specific geographical areas
or circumstances, and should only be relied upon after consulting
an appropriate expert, such as an attorney or
accountant.