Understandably, there will be times when financial resources are limited for most small companies. When you need to make singular investments or when production or sales are down, it’s critical to have a plan in place. Do you know your break-even point? You want to keep cash in the bank and the balance sheets on an even keel. Such a strategy is called a break-even plan.
This plan helps you to figure out the tactics to employ such that expenses are covered, using calculations of:
- fixed costs (ex. payroll, utilities, insurance, debt payments)
- variable costs per unit of sales (ex. production hours worked)
- revenue per unit of sales (ex. $10.00 profit for a particular product)
Why Should You Become Aware of Your Numbers?
Whether your business is a start-up or a long-running operation, becoming aware of the numbers related to earnings and expenditures will help you know what to do when a financial shortfall occurs.
When income doesn’t cover costs, owners need to be extra-careful to ensure obligatory expenses like payroll and accounts payable are met.
Unexpected things happen (like system or machinery outages, weather damage, staff turnover or ramp-up) … at those moments, you may need to do things like temporarily cut fixed costs and increase sales to make up for unforeseen losses or expenditures.
Case in point: A key piece of the production process, a 3-D printer, suddenly stops working. To continue to make sales, the printer must be operational. So, you must either buy a new one or engage an expert to repair it. The out-of-order printer causes immediate losses in income and also the cost of repairs or replacement, which causes a shortfall in cash to pay invoices, debt, and other financial responsibilities.
Knowing the elements that comprise a break-even plan is crucial to prepare for unanticipated events.
How To Create A Break-Even Plan
First, determine your break-even point; of course, this figure will differ from business to business.
There are two main situations that result in different actions or expected outcomes:
Break-Even Point Is High:
- In this case, a company is forced to have a broader customer base to ensure more income
- Spends less time in making a product that all customers like but on a product that most of them won’t dislike
- With time, this situation leads to the need to decrease price points and margins
- With the decrease of prices and margins, company owners may have the temptation to increase the break-even point again, creating a vicious cycle.
Break-Even Point Is Low:
- Owner begins to target smaller and more attractive niches (examples?)
- Company can provide more value (like better quality or faster turnaround) to the customer since these owners typically know their niche needs
- By providing more value, the business builds a better brand, which leads to a justifiable increase in prices or margins
- Over time, higher prices or margins allow for a reduction in break-even point.
Having a low break-even point allows for (1) diversification in a financial lull; (2) more value to customer; (3) stronger branding; and (4) decrease in the break-even point.
Here Are Some Best Practices to Implement a Break Even Plan
Some recommendations and ideas when developing or implementing a break-even plan:
- When creating a break-even plan, you should ensure that managers have a chance for input or review during development and, say, annually.
- At a minimum, include the following in the plan:
- Calculated break-even point
- A point-in-time plan to cut fixed costs (ex. reduce insurance coverage or carry out temporary layoffs)
- Suggested approaches to increase sales (ex. coupons or marketing campaigns)
- If business draws near the break-even point, owners and managers must act immediately to ensure debts can be repaid and there are sufficient funds for payroll, insurance, and other mandatory expenses by one or more of the following choices:
- Cutting fixed costs as much as possible
- Implementing a way to increase sales
- Temporarily increasing prices
- Attempting to collect unpaid debts or balances
- Obtaining a short-term loan
- Avoid the common mistake of just cutting costs and then increasing prices.
- When implementing break-even plan, ensure that customer service becomes a higher priority in order to maintain customer satisfaction.
A well-considered break-even plan requires some investment of time, thought, and financial facts, but yields a very high return when a shortfall in cash occurs. Not only can such a plan save a company from financial crisis/ruin and help lower its break-even point, but also can lead to more stability and the opportunity for you to raise prices. Do you have a break-even plan in your business? Do you think it would help you?