This is the fourth in a series of articles about how to put together your business and financial plan for 2017 which started with Understanding Business Growth Strategy. In this article, I’m going to focus on a key point in the life of a small business that most entrepreneurs neglect. The breakeven or ‘sleep easy at night’ point.
Breakeven point is your first key marker on the road to profitability and financial success. Achieving this means that your business is self-sufficient, a major feat for most small businesses. But too many businesses fail to reach breakeven point, and then have to shut up shop.
When I’m working with a new client, one of the very first things I do is check whether the business has achieved breakeven point or not. This, and check their cash flow forecast. I want to know how long we’ve got to hit profitability if the business isn’t there yet. I’m currently working with three businesses in turnaround. One business in particular has been haemorrhaging thousands of pounds of cash every month this year, and will have to cease trading if these losses can’t be arrested quickly. Following our second month of working together, we’ve reduced the gap by 50%. If this trend continues, the business will hit breakeven for the first time ever within the next 3 to 4 months.
What Is Breakeven Point?
Breakeven point occurs when net revenue (your gross sales less any discounts and refunds) is large enough to cover your fixed and variable costs, and has the potential to generate sustainable profits. You’ll find all the information you need to calculate your breakeven point on your Profit & Loss Report. If you can’t generate an accurate, monthly Profit & Loss Report, make doing so a top priority.
Why Is Achieving Breakeven Point Such An Accomplishment?
Well, net revenue tends to come in slowly and unpredictably during the early days of running a business. It takes time to build up a reputation and a solid customer base. It takes time for customers to fall in love with a product or service and become ‘brand evangelists,’ spreading their enthusiasm to their family, friends and colleagues so they become customers too. It takes time for our marketing efforts to kick in. Remember the Marketing Rule of 7?
It takes time to measure the trend of net revenue so you can predict what products and services your customers will purchase, how much and how often they’ll buy. Building net revenue always takes longer than you expect. That’s why it’s important to keep an iron grip on expenses whilst aggressively marketing your business.
How To Discover Breakeven Point
Breakeven point is the place where the number of units (your products and services) sold and therefore your net revenue, is high enough to cover both your fixed and variable expenses.
To calculate your breakeven point, you need to know your breakeven volume, the number of units you need to sell to hit your particular breakeven point. As I love cafes and cake, let’s stick with my example in How To Prepare A Sales Forecast – Part 1, take cup cakes as an example. (Substitute chocolate brownies, a slice of lemon drizzle cake or as we’re approaching Christmas a mince pie, to your taste).
Let’s assume that we can sell an individual cup cake for £3.00, and it costs £0.25 to make. This means every cup cake will generate £2.75 in gross profit which goes towards covering our café’s fixed and variable costs.
Now let’s assume that the fixed and variable costs of running the café are £82,500 per annum. Clearly we’ll have to sell a lot of cup cakes to cover these expenses. 30,000 in fact or 2,500 cup cakes per month. That’s a lot of baking!
The equation to calculate breakeven volume is simple:
Fixed and Variable Expenses Divided By Net Margin Per Unit
= Breakeven Volume
Or in the case of our café:
£82,500 divided by 2.75 = 30,000 cup cakes per annum
Which is 2,500 cup cakes per month
If you run a service based business, the calculation is exactly the same. You simply substitute the number of hours the business has to bill to cover its fixed and variable costs because you’re selling time and skill.
It takes time to reach breakeven point. This is one major reason why the failure rate of small businesses is so high. Most people think that the problem is that they run out of cash. But more often than not the problem is that they’ve run out of time.
What I’d like you to understand is that reaching breakeven point is a race against time. Our primary goal is to hit breakeven point as quickly as possible so that our expenses don’t sink the business before net revenue has had a chance to catch up. The way we buy the time our business needs to breakeven is to keep expenses as low as possible for as long as possible, especially in a weak economy. But without making false economies. We’ll explore this in more detail in my next article.
Join The Conversation
Question: Is breakeven point something you’ve thought about in your business? I
Explore These Additional Resources
Did you miss?
- Understanding Business Growth Strategy
- How To Prepare A Sales Forecast – Part 1
- How To Prepare A Sales Forecast – Part 2
- Marketing In A Weak Economy
- Sky Rocket Your Business With The Marketing Rule Of 7
Work With Me
I’m Denyse Whillier, a London based business coach and consultant. I guide entrepreneurs from across the globe to achieve profitable, scaleable growth and create businesses that are Built To Succeed™. Built To Succeed™ is my proven success system, developed during my 8 years in the trenches as a CEO, 25 years’ experience at senior leadership and managerial level and training at Cranfield School of Management, the UK’s leading business school. It’s this background that sets me apart and helps my clients to get BIG results.
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