In the last post I demonstrated a simplistic approach estimating how much rent a merchant can afford. It was a simple matter to calculate the number of units a sunglass merchant must sell to pay his rent. Let’s reexamine the sunglass merchant and his RMU business, but this time we want to know what minimum sales volume is required to support the business, not just the rent expense. This will be learned by performing a break-even analysis.
Break-even is the sales volume at which neither a profit, nor loss is incurred.
Calculating the break-even point takes into account all of the merchant’s costs; both variable and fixed. To calculate the break-even point in units, use:
Break-even = fixed costs ÷ (sales price – variable costs per unit)
Fortunately, RMU businesses aren’t very complicated, so gathering the required data is very easy. In fact, within thirty minutes, one should be able to enter this data into a spreadsheet (or scratch it out on the back of an envelope) and know with reasonable accuracy if the merchant can afford the mall’s rent.
The fixed costs for our sunglass merchant are easily identified. These are costs that don’t vary with the volume of activity the merchant does in a month. In order to demonstrate the simplicity of this approach, I have created a set of quasi–realistic expenses that a merchant might encounter operating an RMU business.
Assume that the merchant doesn’t advertise; he depends on mall traffic to generate sales. He must have general liability insurance in order to satisfy developer requirements. Sales staff are paid hourly; probably close to minimum wage. The merchant keeps his own books and prepares his own taxes. This leaves only rent, supplies, and worker’s compensation insurance to pay for.
Monthly Fixed Costs for Sunglass RMU
Bank Charges $10
Business License $10
General Liability Insurance $50
Payroll Expense $3,200
Phone and Internet $200
Renters Tax $78
Worker’s Comp. Insurance $45
Total Expenses $6,618 per month.
The variable costs for an RMU business are also easily determined. These are costs that vary directly with volume of business. In our example there are only two:
Monthly Variable Costs for Sunglass RMU
Cost of goods (see previous post) $6.67/unit
Merchant banking fees: typically 3% of the sale.
Assume for simplicity that all of the merchant’s sales are credit card transactions and thereby subject to the 3% merchant banking fee. The gross profit is then reduced by 3% of $20 (the product sells for $20 per unit), or $.60. The gross profit per unit is then:
Gross profit per unit = $19.40 – $6.67 = $12.73
We now have all the information required to determine the merchant’s break-even point. The monthly fixed costs for our merchant are $6,618. The variable costs for this business are Cost of Goods Sold, and credit card processing fee: $12.73. So the merchant’s break even in units is:
Break-even in units = $6,618 ÷ $12.73 = 520 pairs of sunglasses
This then, is the number of units the merchant must sell in a month to pay for all of his costs before he will actually make a profit.
The Break-even in dollars is given by:
Break-even in dollars = Retail Sales Price x Break-even Point in Units = $20/unit x 520 units = $10,398
Our analysis required us to know about a dozen pieces of business data and the only math required was basic arithmetic. In the next post, we will demonstrate how to extend this analysis to a complete line of products where the gross profit and sales volume for each item differs.