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Knowing your breakeven point – the key to weathering economic storms

When stormy economic weather strikes and sales slump, many companies blame their hard times on all sorts of external events, and with good reason. Yet downturns in the economy and buyer’s habits are sure to come and companies must be prepared for it.

Measuring a company’s ability to handle their financial situation is often left to the number crunchers, the accountants in the back office that produce voluminous documents that nobody except other accountants understand, while the business owners prefer to stick to the business of making whatever product the company is in business to produce.

Yet this is a very risky business model.  While it’s true that many of the details of accounting can be left in the hands of experts, there are some fundamental numbers that business owners must understand if the business is to be successful. One of the most important is the breakeven point.

This is simply the level of sales required to produce a profit in a given period of time. Sales must equal the amount of overhead costs plus the costs of the goods sold to reach the breakeven point. A safety margin, say 10%, is usually added for contingencies which are sure to arise.  A company can only withstand a certain amount of time operating below the breakeven point before it runs into trouble. Knowing the breakeven point can serve as the basis for critical decisions that will govern a company’s activities.  Operating a business without having current knowledge of the company’s breakeven point is like trying to navigate a ship without a compass or rudder.  You don’t know where you’re going and you don’t know whether your efforts are taking you there or not. You don’t even know if you’re going forwards or backwards.

Business owners will frequently look at different measures of their company’s activity, such as how many goods are on the shelves, how many operators are at their machines or how much cash is in the bank. None of these indicators are a real indicator of whether the company is headed for good times or bad. Just ask such a business owner “How’s business?” and then when they say “Not bad” or “Could be better” ask “Are you making any money?” and you will find they don’t know.

To be successful and stay in business, business owners need to know whether they are making any money or not!  It’s that simple.  Not in general terms, or last year, but now – this month, this week, today.  In fact, it’s not just something the business owner needs to know, but everyone in the company.  One company we know makes a coded announcement – “Code Black” – over the company’s public address system to announce to all staff that the breakeven point has been reached for the week. Everyone knows that until the company has reached that point in the week, the company was “in the red”, it had not yet had sales that covered its costs. It helps motivate all staff towards the goal of covering those costs, whatever their individual part in the company.

What does this have to with the economy? For the business concerned, everything. When sales drop due to a general slowdown in the economy, the company and it’s staff know immediately and can take action to keep meeting the breakeven point.  This means, in simplest terms, boosting sales and marketing efforts, and trimming costs. It might mean moving staff temporarily from production to telemarketing. This is an innovation that has worked wonders for some companies. Overhead costs might be reduced by finding ways to reduce rent or telephone expenses, for example, while negotiations to reduce the cost of raw materials might contribute to reducing the cost of goods sold.

Knowing the breakeven point and whether the company has attained it in this period of time is the most important measure for a company. If the breakeven point has not been reached, business owners will do what it takes to reach it, but if they don’t know will spend their energies on other things. When other companies are struggling in hard times, the business that tracks it’s breakeven performance will be in a much better position.

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