Do you know how much profit you make each month, and when you make it? Would you be surprised to learn that you don't make a profit on every product or service you sell?
Here's how it works: Your business has fixed costs that you have to pay every month—rent, utilities, insurance, and so forth—even if you don't sell a thing. Hopefully, as you sell your products or services, you have money from each sale to begin covering those fixed costs. Sometime during the month, you will receive enough income to pay all the current overhead costs of your business—a significant milestone.
Up to this point, you haven't earned a dime of profit. Your money has gone to pay the fixed costs and the costs that went directly into the products or services you sold, such as materials, labor, shipping, and so forth. These are variable costs because they depend on how much you sell.
When Total Revenue = Total Cost
At the moment your revenue from sales is equal to your total fixed and variable costs, you've reached your financial break-even point. You begin to make a profit for the first time.
With a quick calculation, you can determine the sales volume necessary to accomplish this goal; however, it can be a little scary. Many businesses don't reach their break-even point and become profitable until the last few days of the month. Up to that time, they are just covering costs—passing income along to vendors, employees, and Uncle Sam
If your break-even point generally comes late in the month, and sales drop a little, you can find yourself on the last day with nothing to show for your hard work but a good time. There is no profit, and likely a loss. A new month begins and you start all over again to pay rent, utilities, insurance, and so forth. You can never change the financial outcome of the past month.
So, your objective is to reach the break-even point as early in the month as possible. The sooner you arrive at this all-important day, the sooner your profit begins to accumulate for the remaining days. The number of days left in the month after reaching your break-even point is your margin of safety. The more the better!
You can do four things—and four things only—to achieve your break-even point earlier in the month:
- Lower your overhead costs (fixed costs)
- Lower the cost of each product or service sold (variable costs)
- Increase your prices (gross margin)
- Increase your sales
Each of these strategies points to one or more business systems that need to be improved. Can you name them?
A Margin Trick
Here's a trick to increase profit, but you have to be careful with it.
Our local Golden Corral Restaurant has a killer deal for seniors between 1:00 and 3:00 p.m. The price of the meal is low and covers the variable costs such as food and labor. It also contributes to the fixed costs, but the meal is not considered profitable. The upside for the restaurant is happy seniors who spread the good word, continuous sell-through of hot and fresh food during the slow time of day (less waste from sitting around), more productive employees, additional seating space for full-price customers during the busy dinner hour, and an overall increase in sales dollars.
Beware: This discount tactic also lowers the margin on the average meal for the restaurant. However, the upsides mentioned more than compensate for the downside. While the profit margin as a percentage of sales goes down a little, the total number of profit dollars goes up! The problem comes when you discount too much and lower the gross margin on your product without an adequate upturn in sales volume. You've just cheapened your whole business and not improved your break-even point.
Which Describes Your Business?
I've seen companies hit their break-even point half way through the month and make a boat load of money thereafter.
I’ve worked with businesses that reach break-even near the end of the month and wonder where their profit is and why they are always struggling with cash flow.
I've also seen companies frequently fall short of their break-even point. They get along for a while living off cash from a decreasing inventory and/or vendor credit terms, but they are doomed unless they apply one of the four remedies described above. After all, profit is the lifeblood of every business!
Do you know what your break-even point is—at what time during the month you begin to make a profit? A Systems Thinker knows the answer to this question. Check out the links below to learn how to calculate your break-even point.