Lessons · Lesson 3 of 6

What a factory has to sell before it earns anything

Turn a whole cost base into one number: how many line-days must be sold before the factory earns a dollar.

Lesson 3 of 6 · 16 min

One number instead of a spreadsheet

A factory owner asks two questions a week, and neither is about a cost sheet. Can we take this order? And are we going to be all right this month? One number answers both, and Tanwir did not have it.

The number is the break-even in line-days. It is how much of the factory's month has to be sold before anything at all is earned. Once you have it, you also have its two children. The margin of safety says how much room you have. The contribution floor is the price test lesson 6 is built on.

Contribution, and the question that decides it

Break-even arithmetic needs the cost base split in two: what changes with the work, and what does not. Materials change. No order, no fabric. Selling, administration and factory overhead do not.

Direct labour is the interesting one. An employment question decides which side it sits on, not an accounting one.

If operators are hired for the order and released when it ends, wages are variable.
If operators are permanent, the wage bill is a fixed monthly commitment and behaves exactly like rent.

At Tanwir they are permanent. Replacing a trained machinist takes eleven weeks, and the factory will not do that for one slow month. So the whole committed wage bill of USD 141,148.80 is fixed. That gives you two things.

Fixed cost a month: factory overhead 121,680.00 + selling and administration 96,400.00 + wages 141,148.80 = USD 359,228.80
Contribution: revenue less materials less other direct costs

PO	Contribution a piece	Pieces a line-day	Contribution a line-day
OST-2260	2.71	684.21	1,854.21
RK-3318	2.57	530.61	1,363.67
BRF-9024	2.01	666.67	1,340.00
CVB-5507	1.73	722.22	1,249.44
KMN-1195	2.68	464.29	1,244.29
PVL-7742	2.50	472.73	1,181.82

What one line-day of each March order contributed, after materials and other direct costs

March's whole book contributed USD 351,520.00 over 273 line-days. That is an average of USD 1,287.62 a line-day.

The break-even

359,228.80 ÷ 1,287.62 = 278.99 line-days.

Tanwir has 312. So the factory must sell 89.42% of itself, at March's mix and prices, before it earns one dollar. It sold 273.

Margin of safety: (273 − 278.99) ÷ 273 = -2.19%

A negative margin of safety is not a warning that the factory is close to trouble. It says the month was already 5.99 line-days inside it. That is what the USD 18,628.80 loss is.

The same factory, one different employment contract

Run it again with labour treated as variable, meaning operators hired to the order book. The picture changes shape completely. Fixed cost falls to USD 218,080.00. Contribution a line-day falls by the labour inside it, USD 452.40, to USD 835.22. Break-even: 218,080 ÷ 835.22 = 261.11 line-days, or 83.69% of capacity. Almost eighteen line-days lower.

That is a real difference, and it is not an accounting choice. It is a difference in what the factory has promised its people. A factory with variable labour breaks even sooner and earns less from a good month, because every extra line-day costs it wages. A factory with permanent labour breaks even later and earns far more once it is past. Both are legitimate. What is not legitimate is running the arithmetic on one assumption and the payroll on the other.

What one line-day is worth once you are past it

This is the half of break-even most people never use, and it is where the money is.

Past the break-even, a line-day costs the factory nothing extra in fixed terms. The rent, the wages and the administration are already paid. So every extra line-day you sell drops its whole contribution into profit.

Average revenue a line-day in March: 974,360 ÷ 273 = USD 3,569.08
Average contribution a line-day: USD 1,287.62
Which is 36.08% of the marginal sales dollar

Near break-even, thirty-six cents of every extra dollar of revenue is profit. That is the operating leverage of a garment factory. It cuts exactly the same way going down: every line-day lost takes USD 1,287.62 of profit with it. Six line-days is the difference between Tanwir's March and a black month.

It also settles an argument that runs in every factory. The sales team says volume. The finance team says margin. Near break-even, with fixed costs this large a share of the base, volume in line-days moves the result far harder than a point of margin does. A point of margin on March's revenue is USD 9,743.60. One extra line-day is USD 1,287.62, so eight line-days beat it. Eight line-days is 2.9% of the month.

The floor

Divide the fixed cost by the line-days you expect to sell. You get the number every quotation should be tested against.

359,228.80 ÷ 273 = USD 1,315.86 a line-day.

That is Tanwir's contribution floor at its real running volume. An order that contributes more than that pays its share of the factory and leaves something over. An order that contributes less is subsidised by the others, however healthy its margin percentage looks.

Look back at the table. Three of March's six orders are below the floor. Lesson 6 is what that cost.

Check yourselfA buyer offers 40,000 pieces at a contribution of USD 1,400 a line-day — above the floor — for a month the factory already expects to fill. Take it?Show the answer

Not on that test, because the floor is the wrong test for a full month. The floor asks whether an order pays its share of the factory, and it assumes the alternative is an empty line. When the line will be sold anyway, the alternative is not zero. It is whatever else could have occupied the day, so the comparison is against that order, not against the floor. USD 1,400 beats the floor and loses to Ostrander's USD 1,854.21. Which test applies depends entirely on whether you can sell the day twice. That switch is the subject of the next three lessons.

What to take away

Convert the whole cost base into one number in line-days. Tanwir's is 278.99 of 312, and it is the most useful number in the building.
Whether direct labour is fixed or variable is a question about employment contracts, not about accounting. It moves the break-even by almost eighteen line-days here. Answer it honestly for your own factory.
Past break-even, operating leverage is violent. 36.08% of every marginal revenue dollar is profit at Tanwir, and the same is true going down.
Divide fixed cost by expected line-days and you have a contribution floor, one number a merchandiser can use in a live negotiation.
The floor is the test for a line-day you would otherwise not sell. It is not the test for a line-day somebody else wants.