are contributing to your profit goal. Strictly speaking, these are product types. You don’t have to know the numbers for every color, size, and style of shirt.
Good news! If one product produces less profit (because of low sales), the other product could potentially make up for it. Ideally, you can adjust your sales between products to maintain the total profit you want. If dress shirt sales are lagging, you can sell more golf shirts.
Applying breakeven point to two products
To plan your sales and profits, it’s ideal for you to know the breakeven point for every product type you sell. So if you have a store that sells just two product types, compute the breakeven points for both of them.
Say you manage a lumberyard that sells two types of wood to furniture makers: Pristine wood and Sturdy wood. A unit is one board of wood. (If you’re selling first-class hardwoods, the sample prices are pretty close to reality. There’s some serious money in a board
Pristine wood is used to make beautiful tabletops and sells for $50 per unit. Variable costs are $30 per unit, and fixed costs total $30,000. The breakeven formula is
Profit ($0) = sales – variable costs – fixed costs
Profit ($0) = (units × $50) – (units × $30) – $30,000
Profit ($0) = units × ($50 – $30) – $30,000
Profit ($0) = units × $20 – $30,000
To finish the calculation, add $30,000 to both sides of the equation. Then divide both sides by $20:
$30,000 = units × $20
$30,000 / $20 = units
1,500 = units
You sell 1,500 units of Pristine wood to break even.
Sturdy wood is used to make pretty good tabletops and sells for $25 per unit. Variable costs are $18 per unit, and fixed costs total $25,000. Here’s the breakeven formula:
Profit ($0) = sales – variable costs – fixed costs
Profit ($0) = (units × $25) – (units × $18) – $25,000
Profit ($0) = units × ($25 – $18) – $25,000
Profit ($0) = units × $7 – $25,000
To finish the calculation, add $25,000 to both sides of the equation. Then divide both sides by $7:
$25,000 = units × $7
$25,000 / $7 = units
3,572 = units
You sell 3,572 units of Sturdy wood to break even.
Pristine wood’s breakeven point in units is less than half of the Sturdy wood’s (1,500 units versus 3,571 units).
A contribution margin of $20 (Pristine wood) beats a contribution margin of $7 (Sturdy wood) any day of the week. The difference in fixed costs is $5,000 — not a big difference. Pristine has a much larger contribution margin to cover fixed costs. That’s why Pristine wood’s breakeven point is so much lower.
Applying target net income to two products
After you compute the breakeven points on two products, you can decide on target net income for the period. Assume again that you sell Pristine and Sturdy wood, and your target net income for both types of wood is $10,000. You target a $5,000 profit for each product type.
Pristine wood’s calculation is
$5,000 = sales – variable costs – fixed costs
$5,000 = (units × $50) – (units × $30) – $30,000
$5,000 = units × $20 – $30,000
Finish the calculation, and you see that it takes 1,750 units of Pristine wood to reach target net income of $5,000.
For Sturdy wood, plug in the variables. You need to sell 4,286 units to reach target net income.
The total profit for both products is $10,000 ($5,000 + $5,000).
Adjusting product sales to reach target net income
If one product’s sales are lower than planned, you can still reach your target net income. Higher sales in one product can make up for lower sales in another product.
For example, say the economy is bad, and customers aren’t eager to buy Pristine wood, so you sell only 1,600 units. The profit calculation is
Profit = $50 × (1,600) – $30 × (1,600) – $30,000
Profit = $80,000 – $48,000 – $30,000
Profit = $2,000
Your target net income for Pristine wood is $5,000, so you’re $3,000 short of your goal. To reach your total target net income, maybe you can shift that $3,000 profit “burden” to Sturdy wood.
To determine how much more you need to sell, just change the Sturdy wood profit to $8,000, and compute the new number of units sold:
$8,000 = (units × $25) – (units × $18) – $25,000
$8,000 = units × $7 – $25,000
Finish the calculation. The number of units to reach your profit goal is $33,000 divided by $7. Therefore, if you sell 4,715 units of Sturdy wood, you generate $8,000. Your total target net income of $10,000 is based on $2,000 from Pristine wood and $8,000 from Sturdy wood.
Costing and pricing a new product
Financial planning for a new product is really difficult, because so many variables are unknown. Product costs, prices, and units sold are based mainly on research and management’s business experience. In spite of these challenges, many businesses successfully launch new products. With careful thought and proper planning, you can introduce a new product and earn a decent profit.
Starting with your product idea
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