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Breaking even

The first financial target of any business is to break even

How do I budget to break even?

When preparing a budget, it is vital to show the level of sales required to cover the expenses. If the break-even sales figure is close to the sales forecast, then there is little scope for error. If you are a new business, investors will look quite closely at the margin of safety when determining whether to provide support.

If you are a service business, you will need to know how much to charge per hour (though you may offer your customers a fixed price). Your hourly rate equals your annual costs divided by your annual productive hours. Remember that not all of your working hours will be productive - some time will be required for promoting your business, buying supplies, doing the books, etc. You will also need to allow for holidays and illness. For any individual sale you will also need to add direct costs. If you are in manufacturing, then instead of estimating working hours start by estimating the number of products that you will sell. Include all costs - including the cost of your time and depreciation of capital equipment.

Once you know your costs and estimated selling price, you are in a position to calculate how many products or hours of your time you need to sell to break even or cover all of your costs. Any further sales will then provide you with a profit. The easiest way to do this is with a graph. The vertical axis measures money; the horizontal axis measures volume of sales. First plot your overhead costs. This will be a horizontal line - because overheads do not vary with sales. Then add direct costs, to show the total cost for a given volume of output.

Now plot your sales. The point where the sales income equals the total costs is the break-even point. The difference between your forecast sales and your total costs is profit (or loss). The difference in volume between the break-even point and the actual sales is known as the margin of safety.

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Is it enough just to break even?

The whole point of calculating the break-even point is to know the absolute minimum level of sales required. If your business is to have a future you will need sales consistently above the break-even point - to give a reasonable profit and to repay any loan finance.

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Are my costs too high?

There is almost always scope to reduce costs. If you cannot increase your profit through additional sales, then you will need to look at ways of reducing your costs. If necessary, seek advice from your accountant or business adviser.

For a new business it is likely that costs will exceed income for the first few weeks or months but you should have a plan that allows for this - and you should still be achieving your sales targets or else you will need to worry about finding the cash necessary to cover your costs.

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Am I charging my customers too much?

New businesses, when asked how they will attract customers, almost always answer by saying that they will charge less than their competitors. This is a marketing strategy known as cost-leadership. It is impossible for small businesses to sustain because they do not have the economies of scale of large businesses. You may also find that if you start with low prices it is difficult to increase them as customers will want to continue buying at the lower price.

So you should pursue a marketing strategy of differentiation - attract customers by offering better quality, or a service or product that is unique, or because you have particular expertise, or by better after sales service, or by quicker service, etc. This will allow you to charge higher prices.

You should, however, regularly review your costs and prices - and adjust your prices as necessary.

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Hints and tips

  • Keep a close eye on your budgeted income and expenditure. If sales are not as high as required, recalculate your unit cost and sale price. If this is a price you cannot sell at, you will need to take action to increase sales or reduce costs.
  • Use your break-even sales volume to set monthly and annual sales targets. If you do not achieve these targets, you will need to take remedial action.
  • Prepare a marketing strategy based on differentiation rather than cost-leadership.

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