Business Alchemy 101 Lesson 18–Break Even Sales Factor (Application)

Spending money you do not have is very common in our society. Many people every day overextend themselves and then end up chained to a debt that grows and grows with no real hope of breaking free.

The cash flow of a business can be quite similar to this scenario. Quite often, a business owner will be passionate about improving and growing the business and spend money on advertising, equipment or man-power that will indeed grow the business but cannot be afforded by the business.

Though not quite as effective as the Contribution Margin analysis, the Break Even Sales Factor can be used to quickly ascertain a company’s cash position to help make decisions about how, when and how much to spend. Consider it wise to establish a base for spending.

For example, set a Break Even Sales Factor of 110% minimum before any cash can be spent to improve the business. That way, you have a sales goal to push for to budget for those important improvements. In doing this, you will be able to stay out of debt and continue to build your business with fewer stresses.

Your business THRIVES on a solid FOUNDATION!

Business Alchemy 101 Lesson 18–Break Even Sales Factor (Part Two)

The equation for this ratio is quite simple and here it is:

(Gross Profit/Total Expenses) X 100 = Break Even (as a percentage)

So to understand the results, we refer back to the article on Understanding Ratios. We want the Gross Profit to win, but we are viewing the ratio from the Expenses point-of-view.

This means that if we have a number higher than one hundred, then each dollar of expenses has to wipe out more than one dollar of gross profit, which means we are doing well. If the number is below one hundred, then each dollar of expense is wiping out more than one dollar of gross profit and we will not be seeing any net profit at the end of the day.

In more technical terms, if the result is higher than 100%, then we are higher than our break-even and adding profit to the company. The total expenses also gives us an idea on how much we need to sell in order to break even.

In the next installment I will go over briefly some applications of this ratio.

Your business THRIVES on a solid FOUNDATION!!!

Business Alchemy 101 Lesson 18–Break Even Sales Factor (Part One)

The Break Even Sales Factor is a very simplified way to find out how much you need to sell in order to turn a profit. The most accurate way to determine this is to use the method discussed under the Contribution Margin topic, but that way takes a lot more work.

To illustrate how this works, pretend I am back in elementary and I bring lunch to school. I have 10 friends that I eat lunch with and we have all agreed to share our treats with each other every day.

One day I have a bag of Goldfish crackers and there are 20 crackers in my bag. I hand out one little cracker to each friend and then there are ten left for me.

However, the next day I have fruit snacks and there are only 8 fruit snacks in my packet, so only 8 of my friends get fruit snacks and I do not get any.

This is how the Break Even Sales Factor works. My friends are all the expenses of my company. The treat is the gross profit of the company (Revenue minus Cost of Goods Sold), and the number of treats left over is the profit I get to eat.

I will go over the equation in the next post.

Your business THRIVES on a solid FOUNDATION!


Business Alchemy 101 Lesson 15–Sales Growth Consistency (Part One)

Sales Growth Consistency is a very simple equation and does not contain any ratios.  The purpose of Sales Growth Consistency is simply to track the number of years that the sales of the company have grown.

The equation is an IF-THEN-ELSE statement.  If you do not know what this is, then I will explain: the meaning of this statement is that IF A occurs, THEN you will do B, otherwise (ELSE) you will do C.  Otherwise, no explanation is necessary. (In case you did not catch it, this paragraph is an IF-THEN-ELSE statement…)

So the equation is:

IF [Sales This Year > Sales Last Year] THEN [Sales Growth Consistency = Sales Growth Consistency Last Year + 1]

ELSE [Sales Growth Consistency = 0]

So a company with a Sales Growth Consistency of 7, would have had 7 years of consistent growth in the volume of sales.

Adversely, a company with a Sales Growth Consistency of 0 did not grow this last year.

As always…

…Your business THRIVES on a solid FOUNDATION!!!

Business Alchemy Lesson 11–How Much Pie Do You Get? (Profit)

Okay, so this is the last post on profit.  I want to address in this post the more familiar version of reporting profit, which is the Income Statement.

I have already explained how an Income Statement can be used and what it means.  When you dissect this Statement a little bit more you can find some more useful information.

Going back to the Thanksgiving dinner analogy and my mother’s pies, you remember that some of my siblings come with their families and some don’t depending on what is going on with the in-laws. Continue reading

Business Alchemy Lesson 7–Top Off Your Tank

How far can your business go at your current rate of operation?

Knowing your gas mileage is not mandatory to drive your car, but it can certainly help.  You don’t have to know how much gas is left in your tank either, but you may run out of gas and end up stranded somewhere.

The same is true for your business.  We have talked a little bit already about your vehicle and some of the different tools for understanding your business and your progress.  The last major tool that I want to explain is the Cash Flow Statement.

The Profit and Loss Statement, or Income Statement, is like the speedometer and tells you how fast you are heading toward your goals and the Cash Flow Statement is like your fuel gauge.  If you run out of gas while driving, your speedometer will drop to zero and stay there until you can put more fuel into the tank.

Your business is the same when it comes to cash.  If you run out of cash, your car will glide to a stop and your business will not progress toward your goal.  You may have to get out and push your car which is usually represented by going into debt and not being able to make your payments.

The key to avoiding this problem is to know how much gas (cash) you have in your car at all times and it doesn’t hurt if you have an idea of your gas mileage also.  When you are able to forecast the amount of cash flow that your company will have in upcoming days, weeks and months, then you can know how far your business can go toward your goals at your current rate and when you need to fill up your car again by implementing strategies to increase sales.

There are three different elements to a Cash Flow Statement, Operating Cash, Investing Cash and Financing Cash.  These three categories show up on the statement, but the most important part  to understand is the very bottom line which shows the change in cash over the specified period of time.

The other thing that I find useful is to graph your cash flow over a longer period of time.  This shows how much cash you have on hand on average.  When you operate in such a way that you average zero cash on hand over a period of time, then you are spending everything that you are bringing into the company.  There are simple adjustments that can be made in your cash spending strategies that can help to keep your gas tank full all the time so you have no delays in moving toward your goal.

The most important strategy comes from the book The Richest Man in Babylon.  The concept is to pay yourself very first when you receive payments.  You need to know what your companies fixed and variable expenses are so you can figure out how much profit your company will make each month.  When you know this, you know how much you will be paying yourself with each check received and you can put that money aside in a separate account to be used to either reinvest into growing your company or to invest in something else.

When you use this strategy, you can make sure that there is always gas in your car.  This principle is very basic, but basic principles are the very most important because…

Without Foundation, your business fails!

Business Alchemy Lesson 6–Do You Have Any Idea How Fast You Were Going?

How fast is your company progressing toward its financial goals?

We have discussed your car in great detail.  I am going to add two other posts to our car analogy that will help to illustrate the importance of the different Financial Statements.

The Profit and Loss Statement—also know as the Income Statement—is your speedometer telling you how fast you are creating cash.  In order to determine this, you need more details.

The two main aspects of a Profit and Loss Statement are Sales and Expenses.  The format of the Profit and Loss Statement is a little more complex than that, but those are really the two basic items on the P & L.

The exciting part of this equation is the Sales.  This is like the gas pedal on a car.  The more sales you make, the faster you are heading toward your financial goals.  Your revenue is really no more complicated than that analogy.

The Expenses of your company are like your brake pedal.  The more expenses you have, the slower you are going toward your goal.  So it goes without saying that the fewer expenses you have, the faster you will go.

Some of the broad categories for expenses include Cost of Goods Sold, Administrative Expenses and Selling Expenses.  These are all subtracted from your Revenues to find your Net Profit.

When you subtract all your Expenses from your Sales, you end up with the total amount of money that you have made which is called your Net Profit.  Your Net Profit is your speed limit.  It tells you how fast you are heading toward your financial goals.

In summary, in order to progress toward you goal faster, your want your Net Profit to be as high as possible.  This means you need to back off on the brake pedal by lowering your expenses, and push down on the gas pedal by increasing sales.  As always,

Without Foundation, your business fails!

Business Alchemy Lesson 5–Making Your Business Go Places

What is under the hood of your business?

Freedom is without argument the foundation for the American Dream.  The easy access to capital has led many Americans to achieve their greatest dreams here in America.

Capital is the private financing of a business and, in essence, the whole reason that businesses exist.  Without the lure of profit, there would be little reason to begin a business.  Altruism can only carry a person so far because at some point a person’s efforts to improve the world must feed, clothe and shelter him or her or else that person will not make it very far with the business.

So, in step the capitalists with their bags of money.  Okay, so if you started your own business without anyone else’s money, you may not have bags of money, but you have certainly invested your money and time into something you are hoping will turn a profit.

This investment, whether from you or from other individuals, is called your Capital or Equity.  This Equity is the engine that runs your whole company.

So back to our car analogy, you hopefully have the shiny exterior, you may or may not have all the fancy innovations of a luxury car in the interior, but what is under your hood?

You want your engine to be the premier in getting people places.  You want your car to be able to get you there safely, efficiently and in the quickest way possible.

The same can be said for your business.  The phrase that it ‘takes money to make money’ is perhaps overused and is not necessarily true, but access to capital to invest in your business sure can help you reach your goals sooner.

So if you have the opportunity to expand the capital for your business, consider the consequences carefully and discuss them with your Accountant, Business Coach, Lawyer and Financial Advisor.  But realize that capital used wisely will help you reach your goals sooner.

The second aspect to consider with your capital is your efficiency.  A large engine is great, but is likely to use up more gas as well.  You want to make sure your engine is as efficient as possible, so that you can get where you are going as quickly as possible, but also so it costs you as little as possible.

The profit of the business falls under the Equity category.  Consequently, all expenses fall under this category also.  Naturally, as you cut expenses, your profit increases and your business operates more efficiently.

The big engine is great and I recommend increasing your capital in most situations, just remember to operate efficiently also.  Keep good records and, as always remember…

Without Foundation, your business fails!