One of the most important figures all business owners should know, is their break even point. Once you know this figure, you can manually calculate whether or not your business has made a profit this month.
This is especially useful if, you are not getting sight of your monthly financial figures.
A short term solution to slow month end figures
It can be so frustrating and worrying. Having to wait up to 2 or 3 months to know what your monthly profit has been. This could be critical to the progress and growth of your business. Surely, there must be a quick way to at least get a fairly good indication of whether you have hit break even this month?
Well the good news is,
Yes there is!
And I would like to share a method I use, which will certainly give you a good feel for your business financial performance, very quickly after the month end.
Of course it doesn’t compensate for the lack of figures and does not give you sufficient insight to help with your decision making. It is just a rough guide which is these situations is better than nothing.
How long should you wait for your accounts to be ready?
Well I believe if you have a bookkeeper processing your figures, the latest you should have a set of figures, should be the 15th of the following month. Your set of figures would be at least
A Profit and Loss Account and a Draft Balance sheet
Any longer and the information may be out of date. The passage of time and events happening since the end of the month, mean that the picture may just have changed since the numbers were calculated.
So, now let’s start with the most important figure for your business.
Sales invoiced in the month is the number one key figure for your business. It tells you what work has been completed or what value of goods have been sent to your customers.
Monthly sales invoiced, enable you to quantify what tangible, income earning activities, have been performed in the month. This of course may be in the form of services or goods. I know many businesses who are busy performing work for customers, but forget that billing the customer is key. The inevitable impact on cash flow then results.
Now, once you have your sales figure, do you know what are all the associated variable costs relating to the sale of your product? Put another way, do you have an idea of what costs are incurred for every £1 of sales made? These would be the costs which are only incurred when you make a sale.
These costs are often referred to as:
Cost of Sales.
Let’s take an example. A business that sells product on line will incur postage, packaging and the trade cost of the good from the supplier, every time a sale is invoiced.
For a service company like a website agency, the cost of sales will be the time value of the website designer working on a particular order. It may also include the new site hosting fee and domain registration fee. You will notice these are readily identifiable cost which are only incurred when a sale has been made.
Remember not to try and over complicate things!
If you cannot readily and easily see the direct relationship between the cost driven by the sales activity, don’t allocate this to this category of costs.
Instead we would classify this as an
Overheads are those costs not directly driven by the sale. Such things as rent, rates marketing, stationery and admin costs are good examples of these types of cost. Also, any staff who are not paid in direct proportion to sales activity are overheads. Hence we often refer to a shop floor operative as being a Cost of Sale, but we classify the Accountant as an overhead.
Here’s a worked example to show you how to calculate your break even point.
|less Cost of Sales||25,000|
|equals Gross Profit||75,000|
|Equal Net Profit||30,000|
It’s not only the absolute values we are interested in, but really what are the ratios we can use. Knowing a simply ratio around these 3 components will enable us to quickly calculate a profit figure, based on the Sales figure.
Calculating Your Ratios
The forecasted or estimated Gross Profit figure is calculated using the following key metric:
Gross profit/Sales % = Gross Profit/Sales X 100
This shows for every £1 of sales, how much Gross Profit is made.
If you know therefore how much Sales you have made in the month and you know this Gross Profit/Sales % it becomes very quick and easy to calculate out what is the likely Gross profit in terms of £’s value.
When to Look at the Absolute figures
When we look at our overheads we are interested in the absolute figure. Just by their very nature, your overheads should be fairly fixed except for adhoc type costs, such as marketing and repairs and maintenance. Most overheads though, can be smoothed and apportioned over 12 months like rates and rent.
Therefore, with overheads, it is possible to get a good handle on what you expect these costs to be in a month. Try having a look back over a number of months at your accounts and you should be able to arrive at a broad likely figure, or even an average figure across the number of months so far.
Quick Calculation of the Net Profit Figure
Very quickly then, based on your sales figure, (which you really do need to know!) you can apply your Gross Margin/Sales % to this to get the Gross Margin made. Then minus your expected average overheads in absolute figures. This will give you a good forecasted Net Profit figure for your business. This figure then can be available to you as soon as you have a reliable sales figure for the month.
Faster Decision Making
Just knowing if you have made a profit or loss will instantly help you.You can make more of those key decisions you need to make now. Furthermore if you collect your sales figures during the month. you will know how much sales you should be invoicing to meet your break even point. Time pressure as we know is a wonderful thing.
So, this is so much better than having to sit on your hands, waiting for your bookkeeper.