How to Calculate Your Breakeven Point
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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.
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
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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.