With end of financial year fast approaching, now is the ideal time to start planning for the new financial year.
I’m sure you’ve heard the saying, ‘failing to plan is planning to fail’, yet many business owners still fail to plan their financials each year.
We recently surveyed local business owners and found that 53 per cent didn’t know their break-even point and only 34 per cent had a budget and forecast in place.
Without knowing these things you are ‘planning to fail’.
The best way to plan for the new financial year is to determine your break-even point and set your budget, so you can plan to succeed.
What is break-even point?
As a business owner, it’s crucial that you know and understand your break-even point. Your break-even point tells you how much income you need to generate to cover your costs.
By analysing your break-even point you can make informed decisions such as whether the business is financially viable, the selling price of your products or services, whether a new product line will be profitable, or if it would be profitable to expand the size of your operating facility.
Five steps for calculating your break-even point
|1. Review your fixed costs (e.g. rent) for the last 12 months and estimate what those costs will be for the next 12 months|
|This also presents the perfect opportunity to set a budget too, but we’ll get to that a little later.|
|2. Identify any other fixed costs you’ll have in the next 12 months|
|Once you’ve determined your fixed costs based on the previous year, consider any other fixed costs that will be coming up that you didn’t have last year.|
|3. Divide your total fixed costs by the number of months, weeks and days you’re open for business.|
|This will tell you how much it costs to open your doors before doing anything else.|
|4. Calculate your average gross profit margin from the last three year|
|To do this, add your gross profit margins from the last three years together, and then divide the number by three. This will give you the average.|
|5. Calculate the sales required to cover your fixed costs|
|OThe formula for this is as follows: Fixed Costs / Gross Profit Margin % x 100% = Break-Even Point|
For example, let’s say you have a business that has fixed costs of $200,000 and a average gross margin of 30 per cent.
Thee break-even would be as follows: $200,000 / 30% x 100% = $666,666
Based on these figures, to break-even this business needs to generate sales of $666,666 for the year.
This can even be broken down into the sales required on a monthly, weekly or daily basis.
By calculating your break-even point, you’ll know exactly what sales you need to generate each day to make a profit and you’ll also know if your business is financially viable.
Using budgets and forecasts to control and improve your results
As mentioned above, calculating your break-even point presents the perfect opportunity to set a budget for your business.
So what’s a budget really? Simply put, it’s a quantified expectation of income and expenditure for a set period of time.
Budgets and forecasts are important because they provide a chance to reduce your fixed costs, plan your sales, plan for your team, assets and cash. They improve motivation by setting a target to aim for, and help you manage your business better and hold people accountable.
Six steps for calculating your budget and forecast
1. Estimate your sales target for the year
Estimate what you think you can produce in sales over the next 12 months by looking at what you’ve achieved historically in sales. It’s a good idea to look at the last three years of sales.
Once you’ve done this, you then need to consider what’s coming up in the next year for your business i.e. future orders / bookings, new products or services, large upcoming projects, products or services in decline?
It’s important to talk to your sales team to gauge demand for your products and services.
Also review your marketing strategies to see what you can do differently this year to increase sales.
Once you’ve collected all your intelligence on past and future sales, you can then determine a figure for the year ahead. Often this involves looking at last year and adding a percentage for growth.
Make sure this is a realistic figure and not just something you’d like to happen – you must be able to justify it.
2. Adjust your sales for seasonal variation
Once you have your sales target for the year, you need to break it down to a monthly target.
You can’t simply divide this figure by 12 as most businesses are affected by seasonal variations.
To adjust your sales for seasonal variations you should:
• List down your sales per month for the last three years
• Calculate the average sales over the three years for each month
• Divide each month’s average sales by the total average sales for the three years
• Work out what percentage of the total sales is produced each month
• Multiply your forecast sales for the next 12 months by those percentages for each month
This will give you a much more realistic target for sales each month, based on your seasonal variations over the last three years.
3. Calculate your average gross margin
These next three steps are exactly the same as when you’re calculating your break-even point. That’s why it’s important to set-up your budget at the same time you calculate your break-even.
So, you need to calculate your average gross profit margin – then take an average from the last three years of business.
This will give you your target gross profit for the year and on a month-by-month basis.
4. Review your fixed costs from the last 12 months and estimate what those costs will be for the next 12 months
Again, this is the same process as in step 1 of the break-even calculation.
Start by reviewing your fixed costs for the last 12 months line by line, and then decide what the level is going to be this year.
5. Identify any other fixed costs that you will have in the next 12 months
This is the same process as step 2 of the break-even calculation.
Include any other fixed costs that you know will be coming up that weren’t in last year’s fixed costs.
You may know you’re going to need to employ someone else or perhaps rent more storage space or lease a car.
6. Set-up your full monthly profit and loss forecast
You now know your monthly sales, cost of sales and gross profit. You just need to divide your fixed costs over the 12 months to produce a full monthly profit and loss forecast.
In most cases your fixed costs can be divided equally over the 12 months, unless you have certain costs that relate to a given month or if you know costs are going to increase in a certain month i.e. you’re going to hire new staff part way through the year.
You can include this all on a spreadsheet to see what your target profit is for each month.
We hope you find the above information useful in calculating for break-even and preparing your budget.
Remember, if you fail to plan you are planning to fail – so get your business in top financial shape this coming financial year.
If you need any help with this, we do offer break-even calculation and budget preparation as a service to our clients and we’d be happy to help you too.
Simply call 07 5596 9070 to talk to an expert now.