By Jordan Horn
A Break-Even Analysis is a useful tool in understanding the level of production or sales volume required to recover your initial investment. Defining sales levels required to cover operational costs allows you to set safety allowances and determine how to set daily, monthly, and annual goals for staff. By communicating these manageable daily goals from the top down, you empower each level of your organization from top management down to frontline employees to positively impact your bottom line through knowledge and trust.
This basic model is also an efficient and effective way to validate any business model. If you can build a reasonable budget, you can determine the break-even quantity and determine if the daily or hourly sales goals are reasonable assumptions to move forward! Just remember these 9 steps:
1. Classify Costs as Fixed, Variable, or Mixed
2. Calculate Total Monthly Fixed and Variable Costs
3. Plug in (Total Fixed Cost) / ((Selling Price) x (Variable Cost Per Unit) = Break-even Quantity
4. Translate Quantity into Daily & Hourly Goals
5. Communicate to Team
6. Track Performance
7. Reward & Improve
8. Revisit & Revise as needed
9. Improve your Bottomline!
The first step is to classify expenses into fixed, variable, or mixed costs and assign budgeted costs to each category. Fixed costs are those that maintain the same month to month such as fixed salaries, accounting and legal fees, telephone, rent, insurance, taxes, and owners draw (owners salary). Variable costs change based on volume changes such as direct labor, commissions, and cost of goods sold. Mixed costs are those that include a variety of a base minimum cost and a variable component once over the minimum is used. An example includes electricity, water, and sewer.
A coffee stand is a great example where you have a consistent product with well-defined hours. While they sell a variety of products, the costs and expenses have a consistent average. By placing assumptions on average revenue per cup, fixed costs, and variable costs per cup you can determine a typical monthly budget. In this model, I assume the average cup of coffee costs approximately $1 a cup and is sold for $3 with fixed costs totaling $7,150. The break-even quantity totals 3,575 cups of coffee required to be sold per month to meet your expenses. At first glance this volume seems out of range of possible. To glean better insights, I recommend taking this to a daily number which is 120 cups of coffee sold a day and an even more manageable just under 10 cups an hour! I know I’ve sat in line between 3 cars to get a cup of coffee and 10 cups an hour is a more reasonable number to grasp than over 3,500 a month!
By starting with a broad overview and taking it down to more digestible numbers you can see that the raw data becomes useful information necessary for an entrepreneur to know regarding their business as well as managers and frontline employees such as baristas. You can then leverage the knowledge you need to sell 120 cups of coffee in a low-tech manner to boost productivity through win-loss calendars and a simple white board to track cups sold as they occur daily.
A simple wall calendar, used to record shift totals of cups of coffee sold, offers a visual reminder of shift totals in a comfortable and manageable format. While each employee is responsible for recording their shifts performance, the manager or owner is responsible to mark a green or red mark through the day to represent a win or loss. When you get to the end of the month you can clearly see days that were at goal or above and those that were below. Then you can utilize that simple detail to motivate through simply communicating the necessary selling levels or find creative solutions to improve poor performing days. For example, offering unique offerings on specific days that are under performing consistently or specific times of day such as happy hour deals. As your business progresses and you anticipate higher returns, you must revise your daily goals to challenge and motivate employees. You can also establish an incentive to your team when they meet and exceed coffee quotas for the month. A small price to pay for drastically improved net profits into your pocket.
Another source of additional income for coffee stands are the food add-ons purchased at an impulse such as donuts, muffins, and sweet breads. If you offer a daily goal for those items as well than you can encourage and leverage baristas to upsell and increase your revenues with minimal effort other than empowering your staff by offering insight and information. Since the original break-even assumptions cover the fixed costs, these add on revenues are simply additional profit! This method of making your main product or primary channel of income cover all fixed costs allows for flexibility and opportunity for secondary streams of income with lower barriers of entry.
Jordan Horn is an accomplished accountant and financial expert with experience in multiple industries. She holds an MBA in Finance from Keller Graduate School of Mangement and a Bachelor’s Degree in Business Administration in Accounting from DeVry University. She enjoys helping others succeed by providing clear and accurate financial information to key stakeholders and by offering innovative solutions to problems.
Jordan is adventurous and enjoys outdoor activities, such as motor sports, camping and exploring. Jordan lives with her husband Dustin, and their two boys, near beautiful Astoria, Oregon.
Follow along on her adventures at www.discoverpines.com and on Instagram @discoverpines