It is often mentioned the importance of monitoring a wide range of ‘performance indicators’ in a business, in order to ensure that appropriate and timely decisions and plans can be made. Given that sales, profit margins and cash flow are the lifeblood of any enterprise, you should put particular emphasis on the importance of getting regular reports on at least these areas of your business.
Alas, most businesses fail to do this.
Far too many businesses blunder their way through the year with little real idea of how they’re progressing. Sure, they might have an idea of what the sales figures for the month were – but less than 1 in 100 would know how that result compared against the same period last year, or whether the profit margins were fatter or thinner, or how many transactions it took to generate those results, or how quickly/slowly accounts are being paid and therefore how the cashflow looks, and so forth. In short, they don’t really know how they’re travelling and so they’re routinely disappointed by what they find on the bottom line at the end of the financial year.
Up to date and accurate financial information lets you make balanced, considered decisions about what you’ll do next, instead of having to rely on hunches and gut feel.
For instance, let’s say a retail business owner has been trading profitably for a while and has been offered the opportunity to take over the space next to his existing store, at a bargain price.
At face value it looks like a good idea. There’d be more shop front and so a greater ability to display merchandise and signage. There’d be more floor space which would allow for the stock to be displayed more attractively. A wider range of products could be carried, to cater for a wider range of tastes. The adjoining space has corner frontage, so two-street access and signage would be available. Extra parking is another bonus.
But is it really a good idea? A “break even” analysis will tell.
You can calculate Break Even by making the following calculation:
Fixed Expenses/Gross Profit ÷ Sales
So, if the business’ Fixed Expenses were, say, $150,000, the Gross Profit was $250,000 and the Sales Revenue was $1,000,000, then the calculation would look like this:
$150,000/$250,000 ÷ $1,000,000
In which case the Break Even would be $600,000. ($150,000 ÷ 0.25 = $600,000).
If the additional space was going to add, say, $30,000 per year to the Fixed Expenses of the business, then the Break Even would increase to ($180,000 ÷ 0.25 =) $720,000. In other words, a $30,000 increase in this business’ expenses would require an additional $120,000 in sales.
Is that realistically achievable? If you’re not sure, a “Volume Break Even” analysis will help determine the answer.
For instance, let’s say the business’ average transaction value is $50. (This would have been calculated by looking at the total sales made in a period of a few ‘typical’ months, then dividing that total by the number of transactions which occurred in that time. For example, if the business made $240,000 in sales in the previous 3 months and 4,800 sales had been recorded, then the average transaction value would be $240,000 ÷ 4,800 = $50)
We can now calculate the Volume Break Even by making the following calculation:
Sales Break Even/Average Sale Value or: $720,000/$50 … which would equal 14,400 “average” sales.
That’s 2,200 sales more than the 12,000 required to break even at the old level.
Once again, is that achievable? The 2,200 extra sales amounts to an extra 44 “average” sales per week (over a 50 week year). That’s an extra 7.3 sales per day, if the business trades for 6 days each week.
Can the business reasonably expect to make that increased number of sales each day as a direct result of increasing its floor space?
But if it seems to be easily achievable … then the decision to expand would be a reasonable one. On the other hand, if it’s unlikely that sales would increase by the required amount … then the vacant space should be left vacant (or the rental should be re-negotiated until it is reduced to a level which makes it viable).
The point is, the analysis would have made that business owner really consider the ramifications of their decision. The extra $30,000 in rent might not seem like a lot … but the extra $120,000 in sales or the extra 44 sales per week might have been a whole lot more daunting. Or those targets might have seemed easily achievable.
Either way, you’d be a whole lot more confident that you’re making the right decision – and a whole lot less likely to wind up broke as a result.
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