I’ve been studying intro marketing for the past few weeks, and one of the more practical things I learned is how to calculate if your business is actually making money.
Let’s invent a little business. We’ll sell used Calvin and Hobbes books online.
I go to Goodwill or some other place where you can find cheap books, and miraculously find 100 Calvin and Hobbes books at 50 cents each! You buy them for $50.
First you need a table, and then you need to pay for a permit, and then you need to pay for 500 hours of table education (so you don’t break the table), then you need to buy some mandatory state-sponsored chicken nuggets (for good nutrition of business owners). This adds up to $500.
The table, permit, education, and chicken nuggets are examples of fixed costs.
Fixed costs are costs that stay the same no matter what.
Variable costs change with the number of sales.
The C&H books would be examples of variable costs.
So we’ve got our expenses: the fixed costs of the table, permit, education, and chicken nuggets, and the variable costs of the books.
Now for some cash!
How much will you charge? Lets say you can manage to sell each book for $5.
Now we can figure out how many books you need to sell to break even or not get into debt.
Here’s the formula: Fixed costs/selling price per unit-variable cost per unit.
Let’s just plug the numbers in: Fixed costs=$500, selling price per unit=$5, variable cost per unit=$0.50
The number of units or books to break even is …
This might seem a little weird, because when you calculate it out, you get an answer of 111.1111111111…
Unless you can sell a portion of a book, you have to round up to the nearest book, 112 books.
So here’s the annoying truth. You will not break even! You have to sell 112 books, but you only have 100!
Here are your options:
b) charge more for each book
c) negotiate a cheaper price per book
d) evade your fixed expenses and go to jail
Eliminating A and D, and seeing that C will be hard to do, we will have to do B, or raise the price per book. Plug in the numbers, this time changing the selling price to $6.
Now, ignoring elasticity (we’ll get into that in a bit; basically means that in general, as you make stuff more expensive, less people will buy your stuff), this should work!!!!
Hope you found this useful.
Secret: I needed to memorize the break-even point formula, and was having trouble doing that, so I wrote this post and made up the Calvin and Hobbes story… so now you can read something, and I can memorize my formula!
I’ll end by putting the formula in big letters