If you are a franchise business owner, or you are thinking about becoming one, one of the most important skills you need in your “tool-bag” is the ability to undertake a break-even analysis
It is a financial calculation that allows you to see how many sales you need to make to cover your costs, and any additional expenditure you are thinking of incurring, before you commit to a particular course of action, allowing you to make any mistakes “on-paper” and be realistic about the outcomes you are likely to achieve.
To be able to undertake a break-even analysis as part of any decision making you need a good working knowledge of:
- Your Sales Revenue
- Your Cost of Sales i.e. the costs which fluctuate based on the volume of sales you make. This could include things like materials, commissions, labour, travel costs etc.
- Your Gross Profit margin
- Your Fixed Costs or Overheads i.e. those costs which will be incurred irrespective of how many sales you make.
At a very simplistic level, your break-even point is your Overheads divided by your Gross Profit Margin which will tell you the level of sales you need to generate just to cover your costs and before you start to make a profit.
Let us suppose that, in a business producing mugs that sell for £5 each:
- The Gross Profit is 70% of sales revenue
- Annual expenses are £30,000
So, to calculate break-even:
- Expenses: £30,000 = £42,857
- GP%: 70%
- As each mug sells for £5, the business will need to sell 8,572 mugs to breakeven (£42,857 / £5)
Now suppose that the company is considering doing some additional advertising to stimulate sales revenue, at an additional cost of £6,000, which would increase the overall expenses to £36,000.
To calculate the new break-even:
- Expenses: £36,000 = £51,429
- GP%: 70%
- As before, each mug sells for £5 so the business will need to sell 10,286 (i.e. an additional 1,714 / 20% more) mugs to breakeven.
Undertaking a break-even calculation first allows you to make an informed decision about whether incurring additional expenditure is likely to deliver the results you are looking for, enabling you to make smarter business decisions.