As a new, growing business, your first benchmark (goal) should be break-even. I would further suggest that break-even be an on-going goal. What? It sounds crazy, but let’s look at two views on break-even and why one view will always be relevant.
Benchmark 1: Accounting Break-Even
All bean-counters, like me, can easily use your income statement and a little extra info to calculate “accounting” break-even. This is the point where you have brought in enough sales to cover all your business operating expenses like cost of goods, rent, utilities, insurance, etc. The paper result is zero net income:
Sales – Expenses = Zero Profit
The true bean-counter version of finding break-even gets a little scary, but let’s cut straight to how to calculate it:
Break-Even Sales = Fixed Expenses / (1 – Variable Expense Percentage)
We just need to separate your expenses into two categories to make this work… expenses that vary with sales, like the cost of your products/services) and expenses that stay the same every month, like rent and insurance. For an example, Jen, sells fried pies and the cost of the ingredients is usually 20% of the selling price of the pie. Her small rented space with utilities and insurance costs $1,000 per month:
Break-Even Sales = 1,000 / (1-.20) = $1,250 per month
Jen has to sell $1,250 in fried pies per month to meet all her expenses. Jen’s bottom-line benchmark is $1,250 in monthly sales. The problem is that Jen hasn’t made anything for herself or budgeted for future capital expenses (like a new oven) or even held out enough to pay her income taxes… enter “Cash Flow Break-Even”.
Benchmark 2: Cash Flow Break-Even
Some accountants would argue with me over the title, but the basic idea of this goal is to look at what you need in sales to cover your business operating expenses, saving for future large expenses, and paying yourself. This is a much more realistic view of what sales number you need to reach in order for your business to be viable. You don’t need to be in business if you can’t pay yourself reasonably. We can easily calculate this break-even number by adding these numbers to the “fixed expenses” portion of our formula. Let’s say Jen would like to budget for:
$750 savings for income tax deposits
$500 for future equipment purchases
The formula now works like this:
Break-Even Sales = ($1,000 + $5,250) / (1-.20) = $7,812.50 per month or $93,750 per year
Now we have a real goal for sustainability of the business. We’ve paid ourselves, the government, and the business (reinvestment). I like to look at this figure yearly, monthly, and daily. To get the daily result, divide the monthly result by the number of days you are open for business. In Jen’s case, if she is open 21 days each month:
Daily Break-Even = $7,812.50 / 21 = $372/day
Jen needs to sell $372 in fried pies per day to meet her cash flow goals. Now, Jen has a tangible daily business goal. She could further break that down into quantity as well. If the price of each fried pie is $3.00, she would need to sell 124 pies per day ($372/$3.00) to meet her goal. Don’t worry about what type of business you have. This same concept applies to service or product-based businesses.
You can get as technical as you want, like adding a growth factor or inflation, but this provides a great, easy-to-understand starting benchmark that every business needs to consider (at least if you want to stay open!)
We provide this metric as part of the basic accounting package at Reach Consulting. Contact me at firstname.lastname@example.org to discuss how we can help take the accounting function off your shoulders and help you make better business decisions.