15 Nov Breakeven Point
The term “Black Friday,” was coined to mark the day that officially kicks off the holiday selling season when many retailers reach their breakeven point for the year. For small business owners the breakeven point is denotes the volume in dollars of revenue at which revenue and expense are equal and there is neither profit nor loss.
With Black Friday coming up on November 24, this is a good time to talk about what the breakeven point means for you as the small business owner.
Why is this important? Any revenue above the breakeven point will provide net profits and any revenue below the breakeven point will produce losses.
The breakeven point is relatively easy to calculate. The only information required is total revenue, total fixed costs and the total of all variable components of the company’s expenses.
The formula is:
In this equation, f is the total fixed costs, v is the total of the variable costs, and r is the current revenue volume.
Understanding your company’s breakeven point will help help you determine where to focus your attention in order to improve financial performance. Do you need to take action to boost revenues, or to change your expense structure? The answer will depend on the specific environment you are operating in at any given point in time.
Think about what happens when you press on a balloon in one particular spot – it will expand somewhere else to adjust for the change in the balance of pressure. No matter where you press, it pops up somewhere else. Managing a business is similar. The question is, where should you apply pressure and what will be the outcome?
As you ponder these questions, keep in mind the breakeven point is not static and can move from time to time depending on changes in the revenue mix and/or the company’s expense profile. For example, if one of your fixed cost elements (let’s say rent) were to increase, this would move the breakeven point to a higher revenue level. In contrast, if the revenue mix changed to include a larger percentage of high margin component(s), the breakeven point would move to a lower revenue level.
If you are in a growing company that has certain minimum staffing requirements and has not yet reached a minimum level of business, chances are you will need to significantly boost revenue to drive acceptable profitability. However, if your company is relatively mature and operates in a more stable (or possibly stagnant) environment, your chances of increasing revenue may not be great. In this case, you will need to reduce overall expenses to improve profits.
You have to decide the action that’s appropriate for your organization. Knowing your breakeven point is an important start.