A simple – but powerful tool

multitool-300x180I was reminded recently how useful the ‘back to basics’ break-even model is – as a tool to assist in the understanding of a business’s underlying performance and profitability.

The concept proved most helpful at a recent client meeting, where the sales director was surprised that an increase in turnover had resulted in a reduced bottom line profit for the business – and some simple break-even analysis helped to demonstrate the effect and significance of the key factors involved.

It may seem obvious but a simple use of the basic model on either historic or projected results can really help a business owner to evaluate the underlying issues in performance.  In addition its use in ‘sensitivity analysis’ (i.e. under a number of ‘what if’ scenarios) is particularly useful when setting budgets or making future projections.  It can also be very useful in the Boardroom, where perhaps the FD and the MD have a number of other ‘non financial’ directors on the Board – where a simpler illustration of the key factors can help provide greater clarity and understanding of the results etc.

The simple formula is: –

Break-even point in sales or turnover (in £’s) =     Fixed Costs (in £’s) divided by Gross Profit %

Therefore, by way of illustration, a business with fixed costs of £900,000 and a gross profit margin of 25% will require an annual sales turnover of £3.6m (or £300k per month) in order to break-even.

By adding the annual amount of profit required to the fixed costs, the level of turnover required to achieve the profit target can be calculated.  Therefore in our example, if the profit target was £500,000, this would require an annual sales turnover of £5.6m, which is a monthly sales target of £467k.

Obviously by holding one of the three variables constant – and changing one of the other – the effect of different levels of sales/gross profit margin/fixed costs on performance can be evaluated etc.

A simple concept – but one that can provide a powerful message.

A final thought …

Looking at the break-even model has also reminded me of the ‘profit improvement’ mantra that is often quoted in business development type seminars – that ‘There are only 4 ways to grow any business’: –

1. Sell more quantity at the same price to your existing customers.
2. Increase the price you charge for the same quantity to your existing customers.
3. Sell to some new customers.
4. Improve the overall business process in some way either by reducing your costs or by improving the efficiency of some operational aspect of the business.

Perhaps despite this cyber-techno world we live in – there is still ‘nothing new under the sun’.

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