You probably didn’t grow up dreaming of a career in accounting. But, I promise you if you don’t understand how the numbers work, you’re going to get yourself in trouble. What is the ROI of this project? If I increase my margins, what impact will it have on the bottom line? What is the break-even analysis for adding a new truck? If this all sounds like complicated financial speak, we are here to help.
Many small businesses owners struggle because they aren’t comfortable analyzing and tracking their financials – there’s just not enough time in the day and there are too many other things to worry about. Anyone interested in building a stronger business needs to understand and use the information captured in financial statements.
That’s where Financial Literacy comes in – you need to be comfortable reading financial statements and to managing the three bottom lines of business financial performance: net profit, operating cash flow, and return on assets – and how they relate to one another. The simple truth is that you need all these three to see the big picture. Finance is the language of business, and everyone, especially entrepreneurs, should know the basics. To begin, let’s focus on what you need to get off the ground – start-up capital and break-even analysis.
Understanding Start-Up Capital
Startup capital refers to the money that is required to start a new business, whether for office space, permits, licenses, inventory, product development and manufacturing, marketing or any other expense. Startup Costs Worksheet – The following worksheet will help you to compute your initial cash requirements for your business. They list the things you need to consider when determining your startup costs and include both the one-time initial costs needed to open your doors and the ongoing costs you’ll face each month for the first 90 days.
These can be printed out to work on…
Understanding Start-Up Capital
Understanding Break-even – The first step of break-even analysis is classifying costs into fixed and variable.
- Because fixed costs have to be met regardless of sales volume, the business must operate at a loss until a certain volume of sales has been reached.
- The break-even point is the point at which there is neither a profit nor a loss; total sales are equal to total costs.
- To make a profit, a business must earn income above this point.
Fixed vs. Variable
- Fixed Costs = Costs that continue even if no units are produced Examples: Depreciation, taxes, interest or mortgage payments, etc.
- Variable Costs = Vary with the volume of production Examples: Labor, materials, etc.
One of the start-up business basics is determining break even – the point where your sales support your overhead. Beyond break-even lies profitability. And while it is just one of many financial ratios we consider – it is a primary decision tool for anyone launching a new venture. It is the feasibility test. “In order for the business to hit break-even, we need to sell 10,000 widgets. Can we realistically expect to sell 10,000 widgets?” Break-even = Fixed Costs/Sales – COGS (Cost of Goods Sold)
For example – I sell hot dogs. My cart, licensing, insurance and marketing run about $600 a month. My food costs per hotdog are $1 and I sell them for $3. $600/$3-$1= 300 hot dogs a month to reach breakeven. Further, if I break this down by the number of days I sell hotdogs – 5 days a week (20 days a month) then 300/20 = 15 hot dogs a day to hit break-even. Most small businesses need to support the owner, so to figure how much I need to sell to make $1,000 a week I add that to the fixed costs. $1,000 a week for 4 weeks = $4,000. $4,000 + $600/3-1 =2,300 hot dogs a month or 2,300/20 = 115 hot dogs a day. So as a prospective business owner, I need to figure out where I can have my cart to make sure I am selling 115 hot dogs a day.
Playing with the Numbers
Obviously, changing the pricing impacts the break-even analysis. If I raise the price of my hot dogs by $1 and assuming all else stays the same – my new break-even is $4,600/4-1 = 1,533 hot dogs a month or just 76 hot dogs a day. Be careful though – raising your prices can impact your sales. If your customers feel $4 is too much, they’ll go buy somewhere else. Your pricing needs to be in line with what customers are willing to pay. Once you understand break-even, then you can tweak the numbers and see the impact on your break-even analysis. We use break-even for every major business decision. If we want a new truck, it lets us know how many billable hours it will take to support the cost of the vehicle. It’s an essential tool to manage your business. We use it to calculate the breakeven of a new employee…
Break-even for new employee
Before hiring an employee, consider the break-even to support the cost of the new hire. Assumptions Base Salary Salary, Benefits & Taxes 1.5 x base salary Employee Cost & Sales/Marketing 2.5 x S, B & T B/E Billable Rate EC & SM/2000 for example – Base – $40,000 per year employee (hourly rate – $19.23/52 weeks) Salary, Benefits & Taxes $60,000 Employee Cost & Sales/Marketing $150,000 B/E Billable Rate $75 (assuming 50 weeks), $150 assuming only billing halftime
How Much Do You Need?
Capital requirements prior to start-up
Begin with the costs which accrue during your preparations for the launch. These include aspects like consultancy costs, notaries’ fees, fees for registrations and permits. Speak to your start-up adviser and work out together what the start-up costs will be.
Capital requirements for the initial operational phase
How much money do you need to spend to get your company up and running? Make a distinction between fixed assets, such as licenses, real estate, buildings, machinery, vehicles and office equipment, on the one hand, and current assets on the other. The latter are the ongoing operational expenses for goods, administration, distribution, staff, etc., the cost of which you will subsequently cover from your income. Since in the initial phase you will have no or little money coming in, you will need to provide the funding for this initial phase in advance. Calculate a period of four to six months for this.
One of the biggest causes of business failure is underestimating the start-up costs plus the amount of cash needed to sustain the business until it breaks even.
- Working through the financials at this feasibility stage will help you to assess how much money you’ll really need to raise beforehand. It also makes sense to work out if your investment is going to bring you a good rate of return.
- For example, if you’re planning to take out a loan or mortgage or use your savings to set up your business:
- How long can you afford to support yourself until the business turns a profit?
- Will all the time, trouble and risk involved in setting up your business be worth it, or would you be better off investing your money elsewhere and working for someone else?