It’s a brand-new year, full of promise and potential. I hope you’re rolling up your sleeves to improve cash flow in 2018.
Wait, that wasn’t one of your new year’s resolutions? Your 2018 budget isn’t in place?
Don’t despair, it’s not too late. The best way to begin is by calculating your monthly break-even point. Last month I discussed the importance of knowing this number. This month, I’m keeping the promise to show you how to calculate it quickly and easily. No Excel. Anyone can do it. In fewer than 30 minutes. Really.
So, close the office door, get out pencil, paper and calculator.
An Easy Way to Discover Monthly Break Even
- Start the stopwatch.
- Print a full-year income statement from QuickBooks. If your December bookkeeping isn’t finished—or even started—then use the latest 12 consecutive and complete months of financial information.
- Identify the indirect/fixed expenses. These expenses are not directly tied to your income. For example: rent, insurance, office supplies. In general, these expenses are stable and independent of revenue. That’s why accountants call them “fixed.” Add them all up. Then divide by 12. That is the monthly overhead number for your business. Write this number down: it’s the first part of your break-even calculation.
- Identify the direct/variable expenses. You guessed it. These expenses move up or down with revenue. You can’t produce your product or deliver your services without spending this money. Accountants call these “variable” expenses. For a manufacturer, it will be raw materials and parts. For a service provider, it’s often labor. Add up all the indirect/variable expenses. Divide that figure into your total revenue number. The result tells you what percentage of your sales is spoken for as direct costs. Write this percentage down, because you need it for the next step.
- Do the math. The rest is a simple equation.
Breakeven Sales = Total Indirect Expenses ÷ ((100 – Variable Expense Percentage) ÷ 100)
I’ll walk you through that.
The first number is the indirect/fixed expense number from step #3. Let’s say our indirect/fixed expense is $500 per month. The second number uses the percentage calculation from step #4. Let’s say our direct/variable percentage is 33%. You would take 67% (100 minus 33%) and divide it into 100. That equals 67% or .67. $500 divided by .67 = $750. That’s our monthly breakeven sales number.
If we sell $750 of product, then 33%—or $250—will be spent on direct/variable expenses. This leaves us with $500 to cover our monthly indirect/fixed expenses. We will have zero dollars left, but we will have covered all of our expenses. That, my friends, is the definition of break even.
- Stop the stopwatch. Was I right? Under 30 minutes? Told ya.
Once you know this number, here are a few more points to keep in mind.
- Don’t forget the balance sheet. If you’re like most of my clients, what you really want to know is how much cash must get to the bank each month to keep the lights on. Last month, we discussed that you may have significant loan payments, owners draw, or other cash outlays hitting the balance sheet. If so, you would be wise to include these amounts as part of your indirect/fixed expenses in step #3.
- Calculate your breakeven by month. Most of my clients find it easier to focus their financial attention on a monthly break-even sales amount. If your brain skews to a longer time frame, multiply the monthly amount by 12 for an annual view.
- Test your breakeven number. You started with your income statement in step #2. If you annualize your monthly break-even sales number, and subtract it from the actual income, you should get a number that is close to the real profit on the income statement. If you added balance sheet amounts, you’ll need to adjust these out of the break-even amount before applying this test.
- What if you don’t like what you see? If you add up all the numbers and find your break-even point breaks the bank, then you’ll want to lower the hurdle you have to clear each month. Check out this post for ways to do that: http://www.normanprof.com/start-loving-your-budget-process.
This is a fast and simple approach to break-even. It’s what I call “a back of the envelope” calculation. Its purpose is to help you quickly discover a critical benchmark for your company.
There are many nuances, ratios, and tweaks to improve the detail and usefulness of your break-even sales number. Please call me for these (if you turn out to a break-even geek like me).
Now start using one of the most important and foundational financial equations of your business. Thirty minutes or less. I promise. Let me hear how long it takes you.
Wishing you lots of positive cash flow.