You know you’re an accountant when—during the turkey dinner, holiday shopping, and assorted festivities—your brain turns to budgeting. That’s on my mind a lot right now, as our firm guides clients through exercises and calculations to give them a detailed forecast of revenue and expenses for next year.
Does the thought of creating budgets leave you pale and twitchy? Then here’s an easy place to start. It’s the foundational building block of any business budget: the break-even point.
The “My Head Is Barely above Water” Number
Break-even is the amount of sales revenue you must create to cover all your fixed overhead expenses, plus any variable expenses. In plain English:
- Fixed expenses are the dollars required to cover rent, insurance, salaries, and all the other costs that come every month—whether or not we sell anything
- Variable expenses are the cash outlays that go up and down along with sales
A break-even income statement would show a net profit of zero. Cash out is the same as cash in. You’re not drowning, but the water level probably hits your chin.
But Wait, There’s More!
We often add other expenses for a more complete calculation of break-even. That’s because our clients almost always ask , “How much money do I need to bring in to keep the lights on?”
This often includes cash disbursements that hit the balance sheet. Things like debt service, paying down credit cards, or owner’s draw. These balance sheet cash outlays fall outside the strict technical definition of the break-even point, and they provide a great segue to my next point.
Why Should You Really Care about Your Break-Even Number?
Forgive me as I step up onto one of my favorite soapboxes. Here are the top five reasons (yup, I’ve got more, so call me if you’re curious):
- It’s the first hurdle you must clear. For a startup, selling above the break-even point is a momentous occasion on the path to viability and sustainability. For the rest of us, if we can’t reliably and consistently meet or exceed our break-even point, we’re heading to negative cash flow and store closing sales.
- It defines the starting point for net profit. You have two choices for increasing your bottom line. Take sales higher above the break-even point, or reduce your break-even expenses. (Or both.) Either way works, but the breakeven point sets the dividing line.
- It heralds the coming of positive cash flow. If you want to increase cash flow so you can—I don’t know—pay yourself more money, then you must know the initial target. You have to understand the dollar amount above which positive cash flow starts.
- It’s a scorecard for growth. As your business grows, so do expenses. If you can keep the break-even point rate of change below the revenue point rate of change, your profits should convert to cash. If not, you’re likely to feel you’re working harder and harder with little to show for it.
- It stirs creativity in the business owner brain. Successful leaders frequently ask, “What can I do to lower my break-even point?” That’s another way of asking, “How can the business get more efficient, less wasteful, and be a better steward of its resources?”
Next month, I’ll show you how to quickly calculate your company’s break-even point. In the meantime, contact me if you need any more convincing that knowing your break-even number is critical to operating a profitable and successful business.
On a related note – If you need step-by-step instructions for developing a full-blown budget, visit my colleague Andy Rockwood’s blog: www.rocksolidbizdevelopment.com/ourblog. Andy prefers the term “profit plan” over “budget,” and his last several posts provide a terrific blueprint to creating a meaningful plan for profit.
Wishing you lots of positive cash flow.
What Can I Learn Today to Improve Our Financial Performance?
You can hear when an engine is running smoothly—or racing or sputtering. The same is true for the financial drivers of your business.
You just need to know what to listen for. The good news is that your numbers are talking all the time!
Here are the best ideas we can find on how to ask your business for the information you need, to understand what it says, and take action on what you learn.
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What’s on Your Reading List?
- The E-Myth Revisited: Why Most Small Businesses Don't Work and What to Do About It, by Michael E. Gerber
- Profit First: A Simple System to Transform Any Business from a Cash-Eating Monster to a Money-Making Machine, by Mike Michalowicz
- Managing by the Numbers: A Commonsense Guide to Understanding and Using Your Company’s Financials, by Chuck Kremer, Ron Rizzuto and John Case