Over the past few weeks there has been a lift in confidence of clients and some are already expanding their businesses so they can grow. While they are aware they will need additional income to cover these expenses there is a simple formula to work back to a break even turnover.
For almost all businesses there are two categories of expenses:
- Costs which vary depending on how much business you do, so every time you make a sale you incur specific costs relating to that sale, these are “variable costs”. These normally make up a fixed percentage of the sale value overall, although each individual sale may be more or less
- Costs which not vary with sales, they will always be the same whether or not any sales are making place. These include items like rent, insurance and advertising, these are called fixed costs
For businesses looking at growing they may be considering taking on additional fixed costs with a view to supporting growth. So a business may be considering taking on an additional salesman, or advertising campaign which will add to the fixed costs.
Working through an example will demonstrate how this works. If we have a business with £100k turnover, 30% variable costs (ie £30k), and fixed costs of £60k that leaves a profit of £10k which is needed to cover dividend payments to shareholders.
- The business takes on a salesman on a salary of £20k
- So fixed costs increase to £80k
- They need to generate a profit on sales of £90k to cover the fixed costs and the £10k for dividends
- The gross profit margin (ie percentage they make on sales) is 70%. Sales of £100k less costs of £30k leaves a profit of £70k which is 70% of sales
- To work out the sales required to support a £90k gross profit, just multiply by 100/70
- New break even sales are £128.5k
In order to cover costs, the salesman needs to generate £28.5k of additional sales. This is a useful, if not necessary, statistic to have about your business. This is a simple example but the principle applies to all businesses. If you would like advice or assistance to calculate this, or in other areas feel free to call. Alastair Wood, AW Accounting, Gravesend, Kent – Accountants who “speak your language”