How to Find the Big Money
Everyone wants to have a “successful” business. But what does the term successful really mean?
There are many aspects to having a successful company, but in every definition the concept of profitability is present. Transcending this, from an overall standpoint, profitability enables the continuance of an organization – and all of the benefits that flow from its existence.
This month I would like to examine a key tool for projecting and examining your profitability – a Break-Even Analysis. But why is this important? There are three benefits to knowing your company’s Break-Even point:
- It enables the establishment of the point where you begin to make a profit
- It allows you to determine a key piece of your working capital needs
- It facilitates business projections and expansion planning
Unfortunately relatively few organizations perform a Break-Even Analysis because they don’t know where to start.
To create a Break-Even Analysis you need three sets of data. You can do this analysis on a monthly, quarterly, or, like
most businesses, an annual basis. Additionally, you can do this for a location, region, division or the entire company.
Your Fixed Costs
The first step is to add up your fixed costs for a given period of time (e.g., monthly, quarterly, or annual). Your fixed costs remain constant in the short run; for instance, your rent, insurance, utilities, etc., whereas your Variable Expenses change in relation to the Revenue of your company. See below for an easy way to identify your Fixed Expenses. The total of your fixed expenses is recorded as a horizontal line your Break-Even Analysis electronic spreadsheet.
Your Variable Costs
Second, you need to identify the variable expenses for your business – which are the ones that change in a direct relationship to your revenue. These include your Cost of Sales expenses (which are the expenses that are directly related to the production of your revenue) and any of your overhead expenses that vary with your revenue, such as support staff, supplies, training, etc.
Creating Your Break-Even Analysis
The easiest way to identify and separate your Fixed costs from your Variable costs is to print out your organization’s Chart of Accounts and for the accounts in your Cost of Sales and Expenses sections mark an F next to each account that is a Fixed cost and a V next to each account that is a Variable cost. Next, generate an Income Statement for the time period you want to use for your Break-Even Analysis.
Then using your Chart of Accounts noted with F’s for Fixed costs and V’s for Variable costs, transfer these F’s and V’s amounts from your Income Statement, line-by-line to separate Fixed and Variable sections you have created in the electronic spreadsheet that you are using to create your Break-Even Analysis. Next, total all of the F accounts and the V accounts. The total of your F accounts is plotted as your Fixed Expenses.
Then using your Income Statement determine the percentage relationship between the sum of your Variable Expenses in your electronic spreadsheet and your total Revenue. For instance:
For the year ending December 31, 2100
Company Company
A B
| Total Variable Expenses | $80,000 | $105,000 |
| Revenue | $200,000 | $300,000 |
| Variable Expense Percentage | 40% | 35% |
Using the Variable Expense percentage that relates to your projected Revenue, plot your Variable Expenses starting at the point your Fixed Expense line intercepts your Y axis and show these increasing at the slope of the percentage relationship between your Revenue and Variable Expenses.
Lastly, with both your X and Y axis using the same scale, plot your revenue starting at zero and show it increasing at constant slope.
Interpreting Your Break-Even Analysis
Once you have plotted these three lines, the point where your revenue line crosses your variable expenses line is your 
break-even point. This is the point where your business neither makes a profit nor losses money.
The difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the left of your break-even point represents the loss your business would incur at various levels of revenue.
Whereas the difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the right of your break-even point represents the profit your business would generate at each level of revenue. This is where your Big Money is at.
The lower is the revenue amount at which you reach your break-even point and therefore begin to make a profit, the lower the amount of risk that your business has and the easier it will be to attract investors to your business.
Utilizing Your Break-Even Analysis
As we saw above the difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the left of your break-even point represents the loss your business would incur at various levels of revenue. This information allows you to determine how much working capital you would need at the stated level of revenue to offset the drain on your cash because, in fact you are losing money at these levels.
Whereas the difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the right of your break-even point represents the profit your business would generate at each level of revenue. You can use this information to facilitate business projections and expansion planning. This information also shows you the return that you could receive from growing your company to various levels.
Therefore, creating and using a Break-Even Analysis is a crucial tool you can utilize to create a successful business.
If you need assistance with creating and using a Break-Even Analysis please contact us because we can show you how to fully use this tool create an even more successful business and therefore find the big money.
Fountainhead Consulting Group, Inc. is an Innovation and Business Planning firm. During the past 17 years we have shown over 1,200 companies how to achieve the goals for their business by using our unique, comprehensive and systematic business planning and growth methodology, the Structure of Success™ so they can Work Less, Make More and most importantly Have Fun in Their Business. Using our Structure of Success™ methodology each month we examine one of 12 areas of a business or organization.
Office phone: (770) 642-4220
www.FountainheadConsultingGroup.com
George.Horrigan@FountainheadConsultingGroup.com
