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How do you determine how much profit to make?

Reading Time: 2 minutes

By seeing the numbers you can analyze and plan on what to do to increase operating income either by selling more products, decreasing rent expense by moving into a smaller space, or by using sustainable business practices such as electronic billing to reduce variable expenses such as paper, printing, and mailing costs.

1. First you have to distinguish your Fix Expenses and Variable Expenses

  • Fixed Expenses are expenses that do not fluctuate, costs do not change in total despite wide changes in volume, even though volume changes fixed expenses do not change

Examples : Rent, Salary, Insurance

  • Variable Expenses: Expenses do fluctuate, change in direct proportion to changes in volume

As volume changes variable expenses change

Examples: Material, Labor, Utilities

2. After identifying which expenses are fixed and variable… We can now use the Contribution Margin Income Statement also known as the Variable Costing method to determine your operating income or loss. Variable costing helps manufacturers identify the variable cost of making each unit of a product.  The information is critical to making many of the business decisions, such as whether or not to outsource the product.

  •  Sales

-Variable Cost

Contribution Margin

-Fixed Costs

Operating Income

3. How much Profit do you want to make? You can use this Target Profit formula to help figure that out by calculating your total fix expense and then adding it to your estimate target profit and dividing it to your unit contribution margin.

  • (Fixed Expenses + Target Profit)/ Unit Contribution Margin = Target Profit

4. How to figure out if your sales would cover all variable and fixed expenses? To figure this out you need to figure out the breakeven and what is breakeven?

  • Breakeven is when your revenues equal your total expenses and Operating Income would be zero
    • Breakeven does not mean you are losing money, it just shows that when Operating Income is zero all your fixed and variable expenses are covered and if the amount is over zero that would be your profit or income you make
    • How do you determine how much you need to sell to Breakeven?
      • Break even Units Sales = ( Fixed Expense + Operating Income)/ Contribution Margin Per Unit

This analysis is important because it helps managers prepare for and respond to economic changes, such as increasing costs and pressure to drop sales prices, so companies can remain competitive and profitable.