A very important Key Performance Indicator in any business is its breakeven income. Simply put, a business’s breakeven is the amount of sales that a business needs to earn to not make a profit or loss. This can be measured on a daily, weekly, monthly or annual basis.
However, as I said – this is simply put. It’s necessary to understand that break even revenue for profit purposes may be different to the income required to breakeven for cash flow purposes. This is due to a number of factors, including:
Factors affecting profit, but not cash flow:
- Depreciation on equipment and vehicles
- Write off of goodwill, patents, black hole expenditure (start up costs), borrowing costs
Factors affecting cash flow, but not profit:
- Loan principal repayments
- Purchase of assets
- Payment of company/income tax
- Personal drawings not treated as wages
- Planned increases in working capital, including increases in stocks and receivables
As cash flow is king for any business, I believe that it’s not only important to understand what revenue you require to generate at least to “break even” profit wise, it’s also important to understand what sufficient revenue is needed to be generated to break even cash flow – and if that sales forecast is unreasonably high, external funding sources will need to be sourced to finance the business, such as increased overdraft facilities, invoice funding, extended payment terms with suppliers, equipment finance and so on. Of course, a decision may also be required to reduce costs, reduce additional drawings, re schedule loan principal commitments, review pricing strategies and/ or tighten up credit policies with customers.
Breakeven income can also vary regularly depending on issues influencing the business, both internal and external. For instance all of the following factors will impact on breakeven income:
- Pricing strategies, including discounting
- Purchasing deals, not only with products but also with services
- Changes in business overheads eg increasing or reducing wages, rent etc
So it is very important that business operations are regularly reviewed to ensure that business break even revenue is known.
Once break even revenue is identified, the next step is to develop revenue targets based on an overall profit goal. These targets can then be broken down and monitored on a daily or monthly basis. This way, you can be in full control of your business, working towards a known profit goal, and knowing early whether you are meeting these targets.