Forecasting your success through break-even analysis

NOTE. This article first came out in The Manila Times - Business Times Section, and also at the website: http://www.manilatimes.net/national/2003/may/05/business/20030505bus16.html

You don’t need to consult the mirror on the wall or the crystal ball or the Tarot cards or the lines on your palms or the dwende in your house to know if you will succeed in your chosen business. You yourself can know the profitability of your business idea.

A “break-even analysis,” among other financial projections, is your tool to calculate the financial soundness of your idea. To help you make that final decision to go or not go, you need to prepare a break-even forecast in your initial business planning process. This analysis will tell you if your idea will lead you to your dream of financial independence or will direct you to the poorhouse.

Your break-even analysis will give you a picture of how much revenue you’ll need to make to pay for your expenses and realize a profit. You achieve break-even point when your projected sales revenue equals or barely exceeds your anticipated costs of doing business. When, in your calculation, you easily surpass your break-even point, your idea is a sure winner!

Otherwise, you might need to create different scenarios and determine where you can generate more revenues and lower your costs in order to be viable. Some ways to make your projected revenues exceed your break-even point are:

• Save rent by conducting your business in your home.

• Save rent by leasing a smaller place or subletting a portion of your place.

• Find sources of quality supplies and materials at the least cost.

• Rent, don’t buy immediately. Capex requires big capital.

• Do with the least number of employees.

• Find the most cost-efficient processes and technology. Some Internet websites offer softwares for free.

• Find a niche. Don’t do or sell a lot of products or ser­vices at the same time.

• Do creative and inexpensive publicity and promotions.

• As a last resort, sell your product or service at a higher price.

Although a break-even analysis is mostly educated guesses about your revenues and expenses, be as realistic as you can be and get a good feel of the market and reasonable cost estimates. To prepare this initial analysis of your business idea, calculate and estimate your:

• Fixed costs or overhead. These are your regular expenses and they don’t vary much over time. These include rent, insurance, utilities and other set expenses that you will incur whether or not you generate any sales. If you are in the pastries business, these will be what you will spend for rent, electri­city or gas, oven, salary for your helper, etc. One tip is to add 10 percent into your break-even analysis to cover miscellaneous expenses that you can’t predict now.

• Sales Revenue. This represents your total receipts from forecasted sales activities each month or year. To be valid, project your sales revenue based on your forecast on the volume of business you really expect, not on how much you need to make a good profit.

• Direct costs. This is what you pay to provide your pro­duct or service. This includes costs of materials and supplies that directly go into the making of your product. For example, if you are in the pastries business, this will be what you spend to buy flour, sugar, nuts, cream, etc., that go into each “Food for the Gods” you produce.

• Average gross profit for each sale. This is the money left from each sales after paying the direct costs of a sale.

• Average gross profit percentage. This will tell you how much each peso of sales income is gross profit. To calculate, divide your average gross profit figure by the average selling price. For example, if you make a gross profit of P100 on pastries that you sell for an average of P300 a box of 24 Food for the Gods, your gross profit percentage is 33.33 percent (P100 divided by P300).

• Break-even point. To get this, divide your estimated annual fixed costs by your gross profit percentage to determine the a­mount of sales revenue you’ll need to generate just to break-even. For example, if your fixed costs are P5,000 a month and your expected profit margin is 33.33 percent or .3333, your break-even point is P15,001.50. Meaning, you must make about P15,000 every month just to pay for your fixed and direct costs. This break-even number does not include any profit, or even your own sa­lary.

So now you are convinced that you have a winner in your hand, consider yourself blessed. If after tweaking your numbers here and there you still get a negative result, don’t even think of moving on in that direction. Scrap your business idea while your capital is still intact. A break-even analysis is a great screening tool for your business idea. To start putting real money in your business venture, you need to do more complicated analysis.

These are some financial projections that you need to include in your business plan to round out your business’ financial picture.

• Profit-and-loss forecast. This is a month-by-month projection of your business’ net profit from operations.

• Cash flow projection. This shows how much actual cash you’ll have, month by month, to meet your expenses.

• A start-up cost estimate. This is the total of all the expenses you’ll incur before your business opens.

If you intend to stay in business for the long haul, remove some obvious financial risks and start on the right foot, you still need to make a complete profit-and-loss forecast and cash flow projection. A break-even forecast simply tell you whether it’s worth drafting a business plan for your idea or you’re better off spending your money on a vacation in Iraq now that it is free of weapons of mass destruction.

Consider also some non-financial matters, e.g., pastry lovers prefer freshly-baked products. If you cannot sell immediately, what is the effective shelf-life of your pro­ducts? Who and what is the size of your market? What about competition?

Some wise words from James Waldroop, Cofounder of Waldroop Butler Associates: “The enemy of a good decision is fear–fear of failure, fear of humiliation, fear of making a mistake.”

WORLD PEACE. Contri­bute to world peace by wanting and enjoying what you have. Never mind what your neighbors have.

ASTD 2003. For those wanting to get special delegation rate to the American Society for Training and Development International Conference and Exposition in San Diego, California, this May 18 to 22, simply write Delegation Code of the registration form. You can download the brochure on http://www1.astd.org/astd2003/download_bro­chure.aspx. For hard copy, please call Malou Amante (715-9332) or Philscan (Thelma and Che, 843-1252).

Moje Ramos-Aquino is president of Paradigms and Paradoxes consultants and assists small and medium companies in their human resource and organization development efforts. She could be reached at moje@mydestiny.net.