In this blog I’m going to show you how to avoid the popular misconception that making a sale means making money.
The key number to look at in assessing whether the business makes anything is the breakeven point.
That’s the sales you need to make to just cover all your costs. Anything over the breakeven point is profit and is yours (well, yours and the taxman’s).
If your sales are less than the breakeven point – you’ve got problems.
To understand your breakeven point, you need to think about your costs. Different costs behave in different ways:
Fixed costs – these are expenses which don’t vary with sales. These costs have to be paid regardless of sales volume, so we’re talking here about stuff like rent or the salaries of admin staff.
Variable costs – these are expenses that have a pretty clear link to sales volume. In a franchise business, this will be most of the stuff you have to buy from the franchisor. Stock, for example.
The point is that every unit sold incurs additional variable costs. We have to incur those costs to make the sale – we have no choice. That means that every unit sold results in little bit of profit we can use to pay the fixed costs.
We call that mini profit “gross” profit – a sort of interim profit before we pay for all the fixed costs.
If we divide gross profit into sales, we get the gross profit margin percentage. So, if sales is £100, and variable costs are £75, the gross profit is £25. The gross profit margin is £25 divided by £100 = 25%.
All we’re saying here is that every sale we make provides us with 25% of its value to go towards fixed costs.
By applying a bit of lateral thinking, that means that if we can estimate our annual fixed costs, we can divide the total by 25% to work out what sales revenue we need to break even:
Annual fixed costs = £100,000
Gross profit margin = 25%
Required sales to breakeven (= breakeven point) = £100,000 / 25% = £400,000.
Because £400,000 x 25% = £100,000 gross profit, which exactly covers our fixed costs.
This isn’t an academic accounting thing – you must regularly recalculate your breakeven point. Prices and costs constantly change and without knowing your precise breakeven point you won’t know exactly what profit you are making.
So recalculating your breakeven point should be part of your pricing policy to ensure you’re making money on everything you sell.
If your breakeven point turns out to be higher than your expected sales you have two options:
1) Increase your gross profit margin. Not necessarily by raising prices – maybe you could reduce variable costs or concentrate on selling stuff with the highest gross margins. The latter is particularly useful for franchisees, where there is less scope for price and cost adjustments.
2) Cut fixed costs. This could mean staff cuts, but significant savings can be made in all manner of areas with a bit of effort. Utilities, insurance, motor expenses – almost everything is up for reassessment these days.
Breakeven point is a massively important number for business owners to understand. Get to grips with it and you will have gone a long way to really understanding the nuts and bolts of your business financials.
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‘The Five Biggest Problems Stopping Franchisees Making More Money – And What To Do About Them’
Chris Martin is a chartered accountant and business advisor and has been helping franchisees create and grow wonderful businesses for over 20 years. He is a published author and has written extensively on franchisee tax issues. He passionately believes that whilst franchising is a deservedly successful business format, franchisees are often let down by their franchisors’ failure to offer support and guidance regarding the financial side of running the business. This leaves franchisees frustrated, overwhelmed and unable to grow their businesses to the extent they should. Chris has developed simple systems, support and guidance to ensure franchisees create businesses that provide them and their families the lives they so richly deserve.