Welcome to STA’s most recent blog with the goal of clearing away the financial fog!
Seeking some solutions for your net negative issues? Read on!
For your business to be “in the red,” it means you're operating in a debt, in a deficit, or in a state of being “cash negative." You may have heard a financial professional refer to this as your “operating income.”
Your operating income and net income are not the same thing!
You could survive day-to-day, week-to-week, month-to-month like this, depending on how expenses and bills can line up. Some struggling businesses run like this for a few years!
This is NOT where you want to be. I know the feeling many owners have: Where does my money go? Where is our profit? Why does it feel like running my business costs just as much as it makes?
After inventory, rent, utilities, expenses, wages, all taxes, operating platforms, and anything else: if your revenue is netting a few hundred dollars under than those costs, you’re in the red -- funding (covering) your own business, yourself (or with debt).
Let’s review some current statistics for Product-based Businesses and new Start-ups:
Circa 2019, there were 442,597 brick-and-mortar stores in the US. (NACS, 2020)
There are 2.1 million ecommerce retailers in the US. (etailinsights, 2021)
Total US retail sales for Dec 2020 valued at $540.9 billion. (Census Bureau, 2021)
The average retail transaction value as of 2018 was $53.98. (Vend)
The average gross margin in retail as of 2018 was 50.96%. (Vend)
Mar 2020 - Feb 2021, an estimated 200,000 additional establishments closed due to the coronavirus pandemic, reported by the Federal Reserve.
Around 4.3 million business applications were filed in 2020 -- up 24% from 2019 and 51% higher than the 2010-2019 average, according to Census Bureau’s Business Formation Statistics.
What we can see is that a lot of individuals have started up new businesses ideas since the pandemic. What we can also note is retail, both e-commerce/storefront, is alive & well.
So, how do we get your Product-Based Business out of the Red and into the Black?
(“Into the Black:" a business whose net profit is zero, meaning "breaking even," or greater)
One of the most important calculations you need to plan a viable and profitable business is the “Break-even Point.”
The “Break-even Point”, or BPE, is the calculated point at which your business costs are equal to its revenue -- essentially when your revenue matches your inventory, COGS, labor, bills, etc.
In this way, you can think of your sales as truly funding the cost of your operation, and any additional revenue earned past this point is actual profit.
This calculation helps with business strategy, investing, budgeting, and operational efficiency!
You can calculate your Break-even Point (BEP) in two ways: by Sales, or by Units:
1. B.E. Point (in Sales Dollars) = “FIXED COSTS ÷ CONTRIBUTION MARGIN”
Definitions:
Fixed Costs: Costs that “... do not change, or change only slightly.
Examples of fixed costs… are monthly utility expenses and rent.”
Contribution Margin: “Difference between price of a product and what it costs to make it.”
Contribution Margin = [Sale price per unit – Variable costs per unit] ÷ Sale price per unit
2. B.E. Point (in Units) = “FIXED COSTS ÷ (SALES PRICE PER UNIT – VARIABLE COSTS PER UNIT)”
Definitions:
Sales Price per Unit: “... how much a company is going to charge consumers for (1) product."
Variable Costs per Unit: Fluctuating costs “directly tied to production of a product, like labor hired to make the product, or materials used. Note: These are typically a company’s largest expense.
Variable Costs per Unit = Total variable costs ÷ Total units produced
Let’s try a simple example to illustrate how this calculation works...
Suppose we're a coffee shop, and we’re trying to figure out how many coffees to our B.E. Point
Here are our “cost” totals -- you’ll have to factor in your business’ individual aspects…
Fixed Costs = $8,000 (total, for the month)
Variable Costs = 1.10 (per cup produced)
(Note: Don’t forget hidden costs like depreciation -- replacing tools/machines that wear down.)
Sales Price = $4.50 (a cup)
According to the B.E. Point (Sales) formula, we have to find Contribution Margin first:
[ 4.50 (SCpU) - 1.10 (VCpU) ] ÷ 4.50
[ 3.40 ] ÷ 4.50
= 0.7556
Then, it’s Fixed Costs (let's say $8,000) ÷ Contribution Margin:
$8,000 ÷ 0.7556 = $10,587.61 (rounding up, becomes $10,588.00)
The coffee shop would have to sell $10,588 in a month to break even!
Here are a few additional ways that the numbers can have a huge impact on your business:
Price your products BETTER to ensure profitability and that expenses are met
Catalog all known expenses to have a thorough understanding of your costs
Set Revenue Goals for your business with knowledge of your "starting point"
Measure Risks with a clear financial picture when making business decisions
Seek Financing for your business with required data and proven ability to pay