One of the biggest mistakes entrepreneurs make is not knowing the amount of sales required to break-even. This is especially true with start-up business. So very often start-ups and in a lot of cases, established businesses, take on too much overhead too soon in anticipation of future sales. Before taking on more overhead costs, you must determine your sales break-even point.
A break-even point is when your gross profit equals your overhead costs and your income is zero. While your current Profit and Loss statement shows you whether or not you are breaking even, the real value is in knowing the break-even point in the future. Waiting for your Profit and Loss statement to tell you when you are breaking even can be fatal mistake.
Most entrepreneurs in a start-up make the same mistake that our government made about ISIS and the Iraq army. They under estimate their start-up costs and over estimate their first year’s sales. Knowing your break-even point is important because until you get there, you will be burning up cash. The reason most start-ups fail is because they run out of cash. If a start-up cannot hit their break-even point for six or twelve months, this means that they need enough cash up front to keep them going for that amount of time until they hit their break-even point.
Knowing when in the future you will break-even and then start earning a profit is priceless. Unfortunately, far too often, entrepreneurs are not looking out over the horizon to see what is coming at them. Not knowing is like driving your car by looking in the rear view mirror.
The formula for forecasting your future break-even point is as follows:
- Gross profit percent = 25%
- Overhead costs, e.g. selling, general & administrative costs = $500k
- Break-even sales = $500k of overhead divided by your 25% gross profit percent = $2,000k of sales
In existing businesses, many are not generating cash in this economic environment. Unless they know how much sales they need to break-even, far too many businesses do not implement the necessary action plans to either:
- grow their sales
- improve their gross profit percent
- cut overhead costs
- all the above
If you do not know how much it will take to break-even, then it is difficult or nearly impossible to know how much action you need to take. Not knowing is a principal reason why so very many businesses fail.
Let’s be clear on this point. Your objective isn’t to break-even. It is to make money. In order to make money, however, you first need to know how much sales will it take to make money. Hoping things will get better is nice, but hope isn’t a strategy. A key reason so very many owners do not take action is because it can be difficult and painful.
Laying off a friend or family member, for example, isn’t a lot of fun. Implementing new business practices is uncomfortable; so many owners avoid doing them as they may be unpopular. Many times owners know what needs to be done, but don’t know who to do them. Many owners feel they will look bad to their people if those new practices fail.
Being an owner means that many times you will have to choose between the lesser of evils. Far too often they choose to do nothing. The best way to make these decisions is to consider the cost of the business failing versus the difficulty implementing painful actions. Successful business owners are the ones who bite the bullet and do the right things.
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