Too many times I’ve met business owners whose only focus on the numbers is checking their revenue. Whilst revenue is fundamental for all businesses, focusing on this alone doesn’t give enough information to know whether you’re making a profit or not.
Revenue goals are important, don’t get me wrong. There’s nothing more exciting than getting to that first 6 figures revenue figure, or the half a million dollar mark or the million dollar revenue line.
And like all goals, they serve an important purpose for something to aim for and to then celebrate when achieved.
My issue is that revenue of itself isn’t enough. There’s no point having revenue of say $ 100,000 if your costs are $ 120,000.
That’s where another number comes into play. Break even or what I like to call minimum income. It’s also what is needed to fulfil the key element of presence. Without a business that is at least meeting its costs, your presence in business is at risk.
There is only so long that a business will survive (even with using your personal funds) when it is losing money. But that’s a story for another day.
To determine what your minimum income is, you need to identify your expenses and costs of doing business. Whilst your accountant will probably tell you that you only ned to worry about the expenses (as shown in your profit and loss statement), I like to include other payments, like loan repayments, finance payments, purchase of essential equipment in the figures too.
Why? Because they require payment of money out of the business. For me, minimum income needs to cover all payments from the business.
Assuming you’ve been in business for at least a year or more, the easiest way to find is to get a copy of your profit and loss statement for the past 12 months.
Identify all costs that you would have to pay (and did pay whilst lockdowns were in place), whether business was open for trading or not. These are fixed costs.
Everything else will be variable costs that depend on the level of sales.
Take the fixed costs and divide them by the number of trading days in the year.
Take the variable costs and divide them by the total income and multiply by 100 to get a percentage.
Income $ 450,000
Fixed costs identified as $ 80,000. Assume business open 5 days a week, 50 weeks a year.
Variable costs identified as $ 300,000
Daily fixed costs are $ 80,000 divided by 5 days x 50 weeks = $ 320 per day
Variable costs are $ 300,000 divided by $ 450,000 x 100 = 67%. This also means the Gross Margin is 33% (100% less variable costs percentage).
Minimum income is the income required to cover all costs and make no profit and is calculated as:
Fixed costs divided by Gross Margin
$ 320 divided by 33% = $ 970.
To double check the figures:
Sales of $970 less variable costs at 67% less fixed costs of $ 320.
= $ 970 - $ 650 - $ 320 = 0.
Thus total minimum revenue for the year would be $ 970 x 5 days a week x 50 weeks = $ 242,500.
Based on the example above, the business could lose almost half its revenue and would be at a break even position of no profit and no loss. Knowing this number helps to understand the level of movement in revenue and how it will impact the overall profit.