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Happy Friday Blackboarders,
Very few of us started a business because we’re good at maths. So unless you’re one of the special few, you’re probably like most of the entrepreneurs I speak with. You can tell me:
- Last month’s revenue
- This month’s likely sales numbers
- How much cash you have in the bank, and
- Roughly how much money you have left over each year – aka, your net profit.
You also want the last of those (heck, all of those) to be a higher number, right?
Well there’s a critical number you need to be able to calculate: your Break Even point. In this week’s video I walk you through how, exactly, you can determine this pivotal figure, the point at which your business shifts from loss to profit each month.
It’s not quite as simple as it sounds … but combining a couple of numbers you already have become easier when you can see the extra profit on the other side.
Watch this week’s episode here.
Who is Jacob Aldridge, Business Coach?
“The smart and quirky advisor who gets sh!t done in business.” Back independent since 2019.
Since April 2006, I’ve been an international business advisor providing bespoke solutions for privately-owned businesses with 12-96 employees.
At this stage you have proven your business model, but you’re struggling to turn aspirations into day-to-day reality. You are still responsible for all 28 areas of your business, but you don’t have the time or budget to hire 28 different experts.
You need 1 person you can trust who can show you how everything in your business is connected, and which areas to prioritise first.
When starting and growing a business, there are many critical numbers: your revenue, your profit margin, and how much cash you have in the bank are three figures that immediately come to mind!
And when I talk to existing business owners, they are usually clear about those pieces of financial information. A number that they’re less clear about – but which is just as important – is their Break-Even Point on a monthly basis.
In other words, do you know how much money your business needs to generate this month in order to Break Even (ie, cover all of your expenses, so neither losing money nor making a profit)?
Knowing this figure gives you a specific target when planning any of your revenue or growth plans. If you know how much the business costs to run each month, then you have the first monthly sales goal for example.
If you’re not yet in business, you might think this is an easy figure to calculate, but the reality is that some of your monthly expenses are fixed and some are variable – they are linked to how much revenue you bring in.
In this chapter, I combine that information to share with you the formula to help a business understand where that Break Even Point is and therefore what their formula is for profit.
The first step we need to do is understand what a business’s fixed costs are. These, by virtue have been fixed, are a straight line. This is analogous to the giant pool of money that you put on the roulette table at the start of every month as a business owner. I
f it costs you ten thousand dollars to open the doors, fifty thousand, a million dollars every month to run your business, those are fixed costs. Things like your rent, most of your staff, a lot of expenses overheads, leases, software, all of those things, they’re going to be the same regardless of whether you sell a dime worth of actual business services.
We need to understand those fixed costs and then we need to separate out the variable costs within your business. These are costs that you will only incur when you sell your product.
Almost by definition, they are a percentage of your revenue and I say almost by definition because if you find that your variable costs in and of themselves exceed the actual revenue that you generate from that product, then you’ve got a dog of a business.. You’re going out of business backwards.
I’m not a believer in lost leaders, I can certainly understand that some products or services may have a lower margin but you don’t want to create a business where for every dollar of revenue you generate, your variable costs are more than a dollar because remember the variable costs are going to sit on top of the fixed costs, those overheads that you can’t get out of.
By virtue of your variable costs being a percentage of revenue, you can start to calculate, “Well for every extra dollar of revenue I generate, what extra variable costs will I incur?” This might be the cost of goods sold, the cost of the actual products that you’re on selling, or the cost of the materials that your team use when delivering those services.
I know some businesses where their variable costs one or two cents on the dollar, they’re very very fixed overheads, and I know some businesses where their variable costs are much much higher, by virtue of the fact they are on selling a product at a low margin. If your financial reports, your profit and loss statement does not separate out fixed and variable costs, then you will struggle to discover, which is the point of this exercise, where exactly your break-even point is because your break-even point is calculated by adding the variable costs on top of the fixed costs, and working out where that revenue crosses the line.
Everything that your business generates over and above that break-even point is profit. This is the situation where all of the fixed costs have been met, where you have exceeded the gateway on those variable costs and moving forward you continue to grow the margin as a percentage over their top those variable costs.
As you can see, understanding where that break-even point is gives you a specific target each month that you need to hit as early as possible in the month so that you can exceed and build out that profit. Now there’s other ways of calculating this and there are other more complicated elements like knowing your cash break-even point, which of these expenses and which of this revenue is actually cash as opposed to being calculated by your accountant in another way.
Often, the cash breakeven point is a little bit higher so you can actually find as a business that you exceed the break-even point we’ve calculated today but your cash flow continues to go backwards. If you’re finding that’s the situation, then you definitely need to do a more detailed analysis of your profit formula.
This is something that your accountant is definitely able to help you out with and as I say, a good accountant will always pay for themselves when it comes to helping you to grow your business and hopefully today, you’ve seen, just using those four simple elements, fixed costs, variable costs, your revenue, and then ideally that profit, how you can calculate this number for yourself.
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