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RISCORE's February Recipe for Small Business SuccessBreak Even
Will your new business succeed? Here’s a simple test you should do before you quit your job or invest your life savings.
Let’s say you’re opening a retail store. The average price of the products you sell is $10.00 You buy those products from a distributor for $3.70 plus you have to pay sixty cents each to get them shipped to your store. So the variable cost each item you stock is $4.30 and when you sell it you clear $5.70 dollars. Your accountant will call that $5.70 Gross Margin.
Now add up what it costs you to operate your store every month. Let’s say your rent is $600, your utilities (heat, electricity, internet connection) cost another $300, Insurance $80 (prorated monthly although you pay it yearly), licenses and taxes $100, and advertising $200. You don’t have any employees but you take a monthly “draw” of $1500. So every month your “expenses” or overhead are $2780 and these expenses are “fixed”; they go on each month whether you sell anything or not.
Now divide your $2780 fixed monthly expenses by the $5.70 Gross Margin you make on every sale. Voila! If you sell 487.7 items – round it off to 488, you will break even. That is you will make just enough to cover your expenses. You will need to sell more than 488 units to make a profit; if you can sell 588, that extra hundred units at $5.70 each will earn you $577. If you don’t think you can sell 488 units you should rethink your plans.
This simple analysis will lead to all kinds of questions about how to improve the plan for your business. If you raise the price to $10.50, will you still sell as many item? – probably not, what is your competitor charging? What if you increase your advertising? Can you lower your utilities? … and on and on. Work these numbers over, test your assumptions. Go to riscore.org, click on Business Planning, and Advanced Financial Templates and you’ll find a simple Excel spreadsheet that will do the arithmetic for you. Keep trying until you have a business plan that you really believe in. Call a Score counselor if you need help.
And this is not just for startups. I worked for General Electric where we made railroad locomotives; we used break even analysis every year at budget time.
Nelson White
SCORE Counselor
Westerly RI
December 2007