Break-Even Analysis Boosts Dealer Profitability

So you have completed your company's budget for 2005. Congratulations! The budget gives you a spending plan in support of your revenue goal.

And, you have also input the data into your accounting software package so you can pull an Actual vs. Budget Report every 30 days. This report is a great management tool to keep your business on track to achieve all of your financial goals.

The most effective business people manage their operations based upon projections and results measured in numbers'not intuition and hope.

Another effective management tool that is a direct outgrowth of the budgeting process is a Break-Even Analysis.

To calculate your firm's Break-Even Point, first identify each Budget Account as either a variable or fixed expense. As a kitchen and bath dealer, your biggest Variable Expense will always be the Cost of Sales'the materials, labor and freight that go into each project you sell. Examples of other Variable Expenses include Sales Commissions, Sales Payroll Taxes, Advertising, Marketing Tools, and Travel/Entertainment. Examples of Fixed Expenses are Salaries, Rent, Leasing Contracts, etc.

Having properly coded your Variable and Fixed Expenses, Figure 1 shows the other seven steps involved in determining the Break-Even Point, using an operation with a budgeted income (i.e. defined as the sum of substantially completed projects) as a sample. You can proof the Break-Even Analysis by doing the following math: Fixed Expenses + Operating Profit/CM Ratio. The result should equal the Income or Revenue for the period.

The Break-even Analysis

Most employees probably think their dealer-owners are getting rich in this business. Now imagine your employees' response to the news that your company won't earn Dollar One in Net Profit until it completes $781,277 in projects. That should get their attention!

Indeed, it has been my experience that this astonishing fact will give your staff a vigorous new respect for your firm's bottom line needs. Design assistants put more detail in their drawings. Estimators are more precise in their calculations. Salespeople work a little harder in securing the highest price possible (particularly with demanding customers who will require a lot of hand-holding). And project managers get subs to perform more efficiently so projects are completed as much on schedule as possible.

Of course, the information needs to be presented and used properly. Without producing the budgeted $1,000,000 in business (at the projected Gross Profit Margin), there won't be any Net Profit to finance the new truck and computers that are needed. There won't be any Net Profit to pay for the 15% expected increase in Health Insurance, forcing the company to cut back on these benefits. And there won't be any Net Profit to fund a future Retirement Program that everyone seems to want. All because the company's budgeted Net Profit isn't made until the final $218,723 worth of contracts are satisfactorily completed and invoiced.

Now weekly production meetings can have a real focus. With the jobs underway, how many will be able to be invoiced by the end of the month? Will the firm achieve the $65,106 monthly Break-Even Point in revenue? Will the owner be in position to spread around some praise?

And now, quarterly management review meetings can have an additional focus. Based upon the company's cumulative financial performance to date, has the Break-Even Point changed at all? Will it be a little lower because the contribution ratio came out higher than budgeted? What will the new Monthly Break-Even Goal be for the staff over the next quarter?

Projecting Net Profit

By the time October rolls around, owners can make good use of another application for the Break-Even Point. By accurately projecting the Year-End Net Profit based upon nine-month figures, your accountant can get a head start on effective tax planning. Figure 2 shows how it can be accomplished for the sample operation featured earlier. The result is about 17% more than the original budgeted Net Profit of $75,000. One tax-planning strategy might be to reduce the corporate Net Profit below $50,000 where the payment to Uncle Sam is only 15%. A good accountant can consult with you on a menu of options to achieve this objective, but only if you have a good command of Break-Even Analysis and what it can accomplish for you.