Gross Profit Margin

Break-even analysis allows you to determine the business income necessary to pay all your business expenses. At the break-even point, a business doesn’t make any money, but also doesn’t lose any money. In general, you want to know a business’s break-even point because it represents a sales level you must surpass to make money.

To calculate a business’s break-even point, you need to tally those expenses a business must pay regardless of the sales volume. In a retailing business, for example, fixed costs probably include rent, salaries of sales clerks, and other overhead expenses such as utilities and insurance. If a business’s fixed costs include $2,000 in monthly rent (which also include utilities and property insurance) and $4,000 in salaries, the business’s fixed equal $6,000 a month.

A business’s gross profit margin percentage is the difference between sales and its variable costs expressed as percentage of sales. You can calculate the gross margin percentage either on a per-unit basis or by using total sales and variable costs.

To keep this example easy, suppose you want to calculate the gross profit margin on a per-unit basis. If you own a retailing business that sell T-shirts for $15 and the T-shirts cost you $3, your gross profit margin per unit is $12 or, restated as a percentage, your gross profit margin is 80 percent, calculated as $12 divided by $15.

To calculate a break-even point, you figure out how much gross profit margin needs to be generated in order to pay for the business’s fixed costs. In the case of the T-shirt retailing business with $6,000 of fixed costs and 80 percent gross profit margin, the retailer must sell enough T-shirt so that the gross profit earned on the T-shirt pays the fixed costs.

To calculate the T-shirts that must be sold to break even, use the following formula:

Break-even point= (fixed costs/gross profit margin)

In the case of the T-shirt retailing business, for example, you can calculate the number of T-shirt that must be sold to break even like this:

Break-even point in unit = ($6,000 fixed costs/80 percent)

When you divide the $6,000 by 80 percent, you calculate the sales necessary to break even: $7,500. (At $15 a T-shirt, this works out to 5000 T-shirts.)

You can test this numbers by creating a worksheet (by hand or using a spreadsheet program like Microsoft Excel) that describes the income and expenses expected if the retailer sells 500 T-shirts, as shown here:

Income (500 T-shirts @ $15 each) = $7,500

Minus T-shirts (500 $3 T-shirts) = $1,500

Minus Fixed expenses (rent, etc.) = $6,000

Produces Profits (or Losses) = $0

About the author: CPA Stephen L. Nelson wrote bestselling books on Quicken and QuickBooks. More recently, he’s been writing downloadable do-it-yourself guides, including Information about the Corporation, and Costs & Benefits of Incorporation , Incorporating a Business in Texas , Incorporating a Business in Florida, and Incorporating a Business in Washington.

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