Monday 3 December 2018

What's the point in a 'Break-even' point.

Accountants learn about the  'Break-even' point whilst studying for their professional exams. 


Many though will rarely, if ever use it during their working life.

I think it's a useful and under-utilised tool however, particularly for start ups and early-stage businesses but also to established businesses who struggle with achieving consistent profitability

So what is it?

Well, essentially it is the level of sales or sales units needed in a period to cover fixed overheads and break even.

It is traditionally used in a manufacturing environment where the number of units which need to be sold to reach break-even is a critical measure.

It can be applied however to any environment where the cost components of gross margin are relatively uniform and directly related to sales volumes.

Let's look at a restaurant business as an example:


  • The  main 'direct' costs are drink and food ingredients (wet and dry stock) and the labour needed to prepare the food, greet customers, serve the food and drink etc
  • Let's say the labour costs are 30% of sales value and stock is 20% of sales value. So the gross margin is 50%.
  • Fixed overheads rent & rates, insurance, premises costs, directors' and admin wages etc are £20,000 per month.
  • So in this example 'break-even' sales are £40,000 per month. They generate a gross margin at 50% giving £20,000 'quantum' margin which covers the overhead.


So what?

Well getting to break-even should be be the driving force for the business. Every fibre of management's focus and effort should be to getting there and then forging above it.

The main levers are price - is there scope to increase these and still deliver good value and maintain ( or only slightly reduce) volumes, and cost control - ensuring buying stock is effective and payroll and staffing schedules are well managed.

If £40,000 sales per month are needed management should be asking, how are we doing on a weekly basis, or every day? What do we need to change?

The break-even point can be a powerful motivator for change. Once reached, the sales above this threshold are all profit. In our example, every £1,000 sales above the break even puts £500 on the bottom line. That's the happy place where  all businesses should aim to be. The business then has surplus profit for investment or additional return to the shareholders.

So some of the things we accountants learned in school - like discounted cashflow, internal rates of return and correlation coefficients may not see the light of day that much after our studies.

Break-even analysis though is something that I believe should get regular use in every business accountant's tool box.

www.base52.co.uk


No comments:

Post a Comment