Disclaimer: I am not a financial advisor or accountant. This article is for informational purposes only. Please use the info at your discretion.
Last week we talked about what a break-even point is and how managing it can make you (even more) profitable. But performing a break even only tells you how many units you need to sell to break-even. It doesn’t tell you how many you need to sell to make a profit, which brings us to today's post - cost-volume-profit analysis.
Let’s start with the formulas
To look at Cost-Volume-Profit analysis, let’s start with this simple formula:
Total Sales - Total Variable Costs = Total Contribution Margin
Contribution margin is how much you make on your sales after variable costs are subtracted (which you can see by looking at the formula).
Note: Contribution margin can also be used on a per-product basis this can help you compare the contribution margin of various products to see which products make the most per sale.
Ok, now let’s pair the first formula with another one:
Total Contribution Margin - Total Fixed Costs = Profit
Simple, right? We’re just taking what we make on products after variable costs are subtracted (which is contribution margin) and subtracting fixed costs to get profit.
Some other things we know -
- We know total sales is the average price per unit x how many units you sell, so we can use that instead of total sales.
- We know total variable costs is the average variable cost per unit x how many units you sell, so we can use that instead of total variable costs.
- We know total contribution margin can be broken down to a per-unit basis. In that case, contribution margin per-unit would simply be the average sales price per unit minus the average variable cost per unit.
Now, let's put it all together
Let’s use all these formulas to create this sweet matrix:
You can now use this by putting in your numbers and solving. You can set profit at a certain amount and work your way up to figure out how many units you need to sell. Or you can put your predicted sales in at the top and work your way down to project what your profit will be.
Want to see an example? Come back next week for part 2, where we’ll look at an example and talk further about how you can use this to better manage your business.
Part 2 is up! Click here to go to it!