What is My Monthly Breakeven Point of Sales?Posted on August 21st, 2017
Outsourced Accounting Department, Inc.
Assume you would like to know your monthly profit. However, you’ve recently discovered that your largest vendor accidentally over-charged you over a period of several months. In addition, you are recording the payments to your vendors in QuickBooks via a “check” transaction in the month following their related sales, rather than as a “bill” or check transaction in the same month as their related sales. In other words, you are using QuickBooks primarily on a “cash basis” for tax purposes.
This scenario brings to mind another article I wrote a while back, “How You Use QuickBooks Can Distort Your Company’s Profitability.” This is just another variation of the kind of things I mentioned in my article that can distort profitability. But what they all come down to in accounting terminology is the principle of “matching costs to revenues.”
To illustrate, let’s ask this question in a different way: “What is my monthly breakeven point of sales?” The way this is determined is by dividing your company’s total fixed costs by its Contribution Margin after all variable costs (or Gross Margin if all costs in cost-of-goods-sold are variable).
To illustrate the math, assume that a company’s total fixed costs are $100,000, and its contribution margin is 50%. Based on the above formula, this company’s breakeven point of sales would then be $100,000 / .50 = $200,000. But now let’s assume that the company is recording its costs (payments for purchases) directly to cost-of-goods-sold in the month following the sale, such that its contribution margin is now showing as 30% in a month where it had lower purchases. It’s breakeven point of sales in that month is then (theoretically) $100,000 / .30 = $333,333.
So which of the above breakeven sales numbers is correct? That’s a rather important question if you want to know what your monthly sales need to be in order to make a profit, don’t you think?
To further illustrate the above, now look at the below sample company in which I assumed in the projections that the company’s material costs are being recorded as described above (i.e., cash basis). I assume that the check (or credit) from the supplier is recorded all in one month, in this case May. Then, due to the monthly payments being recorded in the month after their related sales, I assume that material costs fluctuate up and down by 5% from month-to-month:
First, notice the graph on the last page, particularly the Breakeven Sales line. Next, look at the monthly volatility in its bottom line Net Income Before Taxes. Then look at the fluctuation in its Contribution Margin at the bottom of Monthly Breakeven page, and the Operating Breakeven Sales above it. The breakeven sales fluctuate up and down from $194,000 in May, to as high as $368,000 in subsequent months. So the question is, exactly what is this company’s “monthly” breakeven point of sales that it must surpass in order to make a profit? Who knows?
Solution: First, understand that QuickBooks is a “transaction-based,”(i.e., “easy-to-use”) accounting software, so it will not (automatically) give you an accurate accounting picture of your business. In order to accomplish that in some situations, you’ll have to make some manual adjustments, usually via journal entries, which means you have to have some idea of the effect on your reports you’re trying to achieve, and the accounting procedure necessary to achieve it.
In the case of this sample company, first a journal entry would be necessary to reallocate the credit for material costs over the applicable accounting period that was affected. I didn’t do that here as this is a spreadsheet model which would require several modifications to get the “Actual” balance sheet data back in balance; however, this could very easily be done in QuickBooks.
Second, the costs recorded in the month after the sales month would need to be journaled back into the previous month by debiting Material Costs and crediting Accrued Expenses (in Other Current Liabilities). Then the journal entry would be “reversed” so as to offset the accounting effect of the checks that were previously posted, but without disturbing the previous check transactions and your bank reconciliations themselves. (Again, this could have very easily been done in QuickBooks, but for purposes of illustrating the accounting effect, I did it here in the projected months only.)
The result end of the above would then look like this:
Note the consistency in the monthly Breakeven Sales that’s now calculated (in the projection period from May on), and the smooth Breakeven Sales line on the graph.
Then going forward, in this example, a “Bill” transaction should be entered for the material costs dated in the same month as the sales (assuming that’s when the supplier’s invoice is also dated), which is then paid via a “Bill Payment” the following month in the Pay Bills window. The Bill transaction in this example then records the cost in the same month as the sale (i.e., “accrual accounting”). See the following for a quick overview of how the QuickBooks accounting process works (in the absence of manual journal entries):
Of course the point of all of this is, the importance of accrual accounting in managing your business, and understanding that QuickBooks does not automatically perform that FOR you. It first has to be set up correctly, and even then sometimes also requires further manual adjustments, both of which require a fundamental understanding of accounting. So if you are not comfortable with accounting, and your financials mean anything to you (which they should or you shouldn’t be in business), then seek proper accounting help.