Dealing with Financial Losses in Cost Accounting
When your unit sales are less than breakeven, you’re operating at a loss. And that could affect the cash you need to operate each month. You likely will need cash to pay expenses (such as rent, utilities, and salaries) before you collect cash from sales.
Every time you incur a loss, it’s likely your available cash balance will decline. Generally, losses reduce your cash balance; conversely, profits increase them. Assume your loss for the month is $1,000. After you collect cash on all of your sales and pay cash for all the bills, your ending cash balance will be $1,000 lower than where you started.
Losses are the curse of business. After all, the business exists to generate profits. Maybe the only good news about a loss is that it gets you analyzing and fixing problems.
Variable costs probably won’t keep you up at night. It’s the fixed costs that may cause insomnia, whether you’re talking about trade show cost, the monthly rent, or salaries you need to pay your employees each month.
You focus on covering fixed costs using the contribution margin (that is, sales less variable costs):
Contribution margin = sales – variable costs
Contribution margin is the money derived from sales after you have covered variable costs, which is used to cover fixed costs and keep for your profit:
Profit = contribution margin – fixed costs
You also can use contribution margin to compute your breakeven point in terms of units. Remember that the breakeven point is the sales needed to cover all of your costs and to create $0 profit). Consider this formula:
Breakeven point in units = Fixed costs ÷ contribution margin per unit
If you sell a software application for $40, and variable costs are $20, each unit has a contribution margin of $20. If you have $1,000 in fixed costs, the formula looks like this:
Breakeven point in units = $1,000 ÷ $20
Breakeven point in units = 50
If you sell 50 units, you’ve covered your fixed costs. Any sales over 50 units are all gravy and put you in Profit Land.