Profitability and Break-Even

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Table of Contents

Introduction
Profitability Based on the Net Return on Assets Ratio
How Profitable?
What Does That Say About the Business?
Break-Even Quantity (BEQ) and Break-Even Dollars (BE$)
Recommendations For the Business
References

Introduction

In the scenario discussed in the following paper, an existing business that sells knitting supplies is being analyzed. The main client demographic is middle-aged women, and the products include a variety of supplies targeted at customers at different levels of proficiency in knitting. Some examples include needles, yarn and fiber, knitting patterns, and complete sets. The business has been running for 5 years and is currently expanding to ship internationally.

Profitability Based on the Net Return on Assets Ratio

To calculate the profitability of the business, the net return on assets ratio must be considered. Average total assets over some time are used for the calculations since the number of sales fluctuates seasonally. Since there is often a surge in sales close to holidays and in the winter, using the average helps understand the real profitability. For the sake of this analysis, the numbers from a year of sales are used, namely from 2020, as the last complete year. The gross income for the period was $250,000 and the net income in 2020 was $224,880. The expenses included in the calculations include website hosting at $10 a month and salary for one employee, $25,000 a year. The average annual total assets for the business are $1,540,000, hence the return on assets ratio is 14.6%.

How Profitable?

The profitability based on return on assets shows the competitiveness of the business in the market. Generally, a return on assets (ROA) of over 5% is considered good (Birken & Curry, 2021), hence it can be said that the business in question is a profitable one. ROA of 14.6% is possible with the business due to the variety of products that are asset-light, such as masterclass workshops and patterns. Furthermore, since there is only one employee, apart from the owner, there are few expenses that go into salaries.

What Does That Say About the Business?

Return on assets shows how efficient the business model is in generating earnings, hence knowing the profitability ratio helps adapt the strategy or business plan. In this case, the business is already profitable but can be improved by changing the shipping model and adding more asset-light features that would decrease the expenses. Furthermore, the business would benefit from the short-term costs of marketing that would increase the client base. Moreover, as mentioned previously, the business is expanding internationally, which would increase the profits further.

Break-Even Quantity (BEQ) and Break-Even Dollars (BE$)

As mentioned in the previous part, there are not many expenses that are associated with the business. Since there is no physical store, only an online website, there are no renting costs. BEQ and BE$, which is the number of units that needs to be sold to cover all costs, can be calculated by using the expenses that the business encounters regularly. The business sells 20,000 units a year, with an average of $12.5 per unit.

If variable costs total $50,000, the variable costs are $2.50 per unit ($50,000 divided by 20,000), the:

The total contribution margin is $200,000 (250,000 minus $50,000)
Unit contribution margin is $10.00 ($200,000 divided by 20,000)
The contribution margin ratio is 0.8 ($200,000 divided by $250,000)
If the annual fixed costs are $85,120 the:
Break-even revenue is about $106,400 ($85,120 divided by 0.8)
The break-even quantity is about 8,512 units ($106,400 divided by $12.5)

Recommendations For the Business

While the business is profitable and has already reached both BEQ and BE$, some recommendations for improvement can be considered. Since the business has a particular demographic, middle-aged women, they are likely to be a loyal client base. Nevertheless, it is vital to expand further, which can be done using social media and online marketing resources. Furthermore, it can be useful to identify the competition and compare the company’s strengths and weaknesses with them (YEC, n.d.). Moreover, it is important to stay relevant and alert to the changes in the market and the preferences of the customers.

References

Birken, E. G. & Curry, B. (2021). Understanding Return On Assets (ROA). Forbes Advisor. Web.

YEC. (n.d.). 8 great strategies to expand your client base. AllBusiness. Web.

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