HMRC Debt Management letters http://t.co/GjFVgesJ
Don't Break The Bank, Break-Even Instead
If your business wants to make a profit then the first step in the process is to understand your break-even point. You can do this per product or service, per category of products or services or even for the business as a whole. The important thing is that you start to understand where your profit is coming from.
The break-even point occurs when total sales revenues are equal to total costs. I think we all know what sales revenues are so let's take a closer look at total costs.
Total Costs
There are two types of costs:
Fixed costs are not dependent on the level of business activity
Variable costs change in proportion to the level of business activity
There are many obvious examples of fixed costs, such as, rent, rates and staff salaries.
Variable costs can be raw materials, commission payments to sales people, delivery costs and utility bills.
Meet Tommy
Allow me to introduce you to Tommy. Tommy has been on holiday recently and by chance bumped into an artisan jewellery maker, Monsieur Bijou, whilst exploring the back alleys of St Germaine in Paris. Tommy works in the marketing department of a major department store chain and thinks that he has spotted a business opportunity.
He returns home and starts to think about the dream of being his own boss. Of doing things his way. Two months after returning from Paris he decides that it's time to stop dreaming and start planning. The first thing he decides he has to do is work out how tough things might be if he goes it alone.
Some Costs
Tommy has a chat with some of his colleagues at work and discovers that it would cost his £10,000 to rent a concession at a branch of his current employers shops for a week. Monsieur Bijou says he can sell Tommy necklaces at £100 per item and Tommy reckons he can sell them for £200 each.
So how many necklaces does Tommy need to sell to make a profit?
In Pictures
Let's start by looking at this problem in pictures:
FIXED COSTS
Fixed costs don't change with the number of necklaces sold so we have horizontal line. It doesn't matter if Tommy sells 200 necklaces or if he sells none, is fixed costs will still be £10,000.
Now let's add variable costs:
We can see that variable costs do change with the number of necklaces sold. If Tommy doesn't sell a single necklace then it doesn't cost him anything. But the more necklaces Tommy sells, the higher his fixed costs.
But remember that the break-even point occurs when total costs and total revenues are the same, so let's tidy up the graph by having a single line that is the sum of the fixed costs and the variable costs:
The total costs line starts at £10,000 with zero neclaces sold. that makes sence because, as we know, if Tommy doesn't sell a single necklace, he still has to pay his rental expense of £10,000. The total costs line changes for each necklace sold which is the variable costs element of the line.
Right, now let's see what this graph looks like when we add in some sales revenue:
The total sales revenue line, perhaps obviously, shows that if Tommy makes zero sales then his sales revenue is zero. His sales revenue increase with every necklace sold.
Our definition of break-even says that it occurs when total costs and total sales revenue are equal, that means:
OK, so the point at which the total costs line and the total sales revnues line cross is the break-even point. That means that if Tommy sells 100 necklaces then he is breaking-even. If he sells less than 100 necklaces then he is making a loss. If he sells more than 100 necklaces then he is making a profit.
One final graph to illustracte the point:
If you prefer to think about profit and loss then we can see from this graph that Tommy only starts to make a profit when he sells more than 100 necklaces. Less than 100 necklaces and he is making a loss.
In Equations
There is an equation that can help us to work out the break-even point:
Fixed Costs
-----------------------------------
Selling price - Purchase price
For Tommy, the equation looks like this:
£10,000
--------------
£200 - £100
Bashing the numbers into a calculator indicates that Tommy needs to sell 100 necklaces to break-even. Tommy reckons that he will sell at least 200 necklaces in a week so he decides to go ahead with his plan.