New Business Year, New Business Plan
The turn of the year is always an interesting time to evaluate where your company needs to be in terms of the sales to break even. Of course the objective is to make a certain level of profit but you are operating blind if the starting point is not a breakeven analysis. Most small companies I work with either do not take the time to do this or do not understand how to do it. The breakeven analysis is one of the fundamental concepts in the business world where the breakeven sales volume is assuming a normal sales mix.
The reason the start of a new year is a critical time to evaluate and understand the underlying factors that go into the breakeven is that the new year brings a new planning cycle which incorporates the changes the company plans to make in the coming year (such as selling price increases, cost increases including payroll, capital asset additions, introduction of new product lines, etc.). There are an endless number of variables that can impact where that breakeven will be for the coming year. You need to do this analysis to get a clear picture of what your actual breakeven point was in the year just concluded and compare that to the estimated breakeven point derived from the budget for the current year.
The benefit of using and understanding this tool is that the analysis projects the profit a company potentially should realize at various sales levels or losses in the case of sales falling short of the breakeven point.
The most accurate way and most arduous way to determine the breakeven point is to first segregate expenses into one of three categories (fixed, semi-fixed, or variable) and then plot a series of points using different sales levels to determine the total expense line. Our Executive Focus team uses a simplified approach which includes utilizing the company’s month by month budget (sales and profit) to generate a linear regression analysis to compute the breakeven point and the slope of the expense line.
Depicted above is an example of a company’s 2018 actual breakeven analysis and the company’s 2019 estimated breakeven analysis based on the current year budget. The challenge for this company is this shows that the breakeven point in terms of sales has increased from $967,000 in 2018 to $1,062,000 in 2019. Furthermore is the fact that the profit beyond breakeven fell from 33% in 2018 to 27% in 2019.
What are the takeaways/action items from this analysis?
We need to first understand what changes in assumptions drove the higher breakeven point – likely cost increases in the budget exceed sales price increases. But where? We need to understand the underlying changes to implement corrective action.
What adjustments can be made?
If the client determines this anticipated profit is not acceptable they have to find ways to make adjustments to how they operate in 2019 – maximize revenues and minimize expenses. Timing is of the essence in making these adjustments in that it goes without saying – the earlier in the year changes are made the longer we reap the benefits of those changes.
At CDH our Executive Focus service offering is all about making your individual internal metrics come alive. For over 40 years we have been helping companies understand and develop impactful KPI’s and using them as a tool to run a highly effective management review meeting for the client to drive continuous improvement. Over the last nine years our clients have averaged 9% sales growth per year and 28% profit growth per year far exceeding their industry averages. If you would like to learn more about our Executive Focus process please contact Dennis Pierce, Director of Management Consulting at [email protected] or 262.784.4040.