Sales, profit and cash are key issues in management. If you get these working, you’re well on your way to a sustainable business with capacity to grow. Most people focus on sales. I’ll begin with profit! The reason is, if you’re making sales without profit, you will go out of business.
The best way to make profit is avoiding losses. Understanding break-even sales is a must.
A Break-even sale is the amount needed to avoid a loss.
I.e., to achieve $0 profit or loss. It’s impacted by fixed and variable costs. Fixed costs are those incurred constantly, e.g., rent, admin wages, etc. Variable costs are incurred in making a sale, e.g., product and associated costs like freight, packaging, etc. When selling a service, it’s labour and materials. When you’ve calculated variable costs per product or job, calculate gross margin. E.g., if a product costs $40 (including all costs to prepare for sale) and you’re selling it for $100, gross margin is 60%.
Now you need to know fixed costs.
Let’s say they’re $30,000 per month. To work out break-even sales, take fixed costs of $30,000 divided by gross margin of 60%, giving a figure of $50,000. This is your monthly break-even sales figure. If average product sale is $100, divide sales break-even figure of $50,000 by average sale of $100, to come up with figure of 500 units to break-even. In simple language, you have to sell 500 units per month at $100 to break-even. Now that you know your break-even sales figure, use this as a basis for targets to achieve desired profit. E.g., with every unit sold above the break-even volume of 500 units, you will make $60 profit, which is the gross margin per unit of sale. Therefore if your target is $6000 profit, you need to sell an additional 100 units.
Gross margin is the most impactful result.
If you can’t make a gross margin, it’s impossible to make net profit. One of the biggest issues is lack of understanding of product or service ‘true cost’. It’s often considered the raw cost of the product or service. Items such as freight, currency exchange, packaging, etc., are omitted when calculating cost. This is dangerous, because when pricing a product and calculating a margin, the true cost isn’t accounted for. In this case, gross margin suffers and reduces funds for fixed costs. The result is losses and constant need to focus on more sales to meet cash needs.
This leads onto Cash Flow.
So far we’ve considered profit… and ‘good cash flow’ comes from ‘profit’. ‘Bad cash flow’ can also come from profit. This arises due to the impact of factors other than profit, i.e., sales less fixed and variable costs. You can make money in the ‘Profit and Loss’ and lose your battle to pay expenses when due, and the key drivers of cash flow are in the ‘Balance Sheet’. The Balance Sheet has more impact on cash flow than anything else. I’m referring to Accounts Receivable, Accounts Payable, Inventory and Work in Progress. When a sale is made, it’s a long way for funds to get into the bank. They’re invoiced to customers who may take 120 days to pay. They’re paid to suppliers who may or may not offer terms. They sit in your stock room as products awaiting sale. They sit in Work in Progress as labour and materials before the job gets finished and invoiced. And that’s on top of paying fixed costs.
Your challenge to keep cash flow healthy is to:
- Minimise number of days customers take to pay.
- Maximise number of days to pay suppliers.
- Minimise number of days goods sit in stock awaiting sale.
- Minimise number of days jobs are in progress before invoicing.
In summary:
- Sell the right products/services at the right price.
- Understand true cost to get the price right and a desired gross margin.
- Know ‘break-even’ sales to target a desired profit.
- Constantly monitor variable costs to maintain margin.
- Constantly manage fixed costs to avoid wastage.
- Constantly manage Accounts Receivables, Accounts Payables, Inventory and Work in Progress.
Tools to help:
- Management systems for:
- Inventory
- Jobs
- Accounts Receivable
- Accounts Payable
- Budget
- Cash Flow Forecast
- Accounts system
All systems need to be set up by someone who understands the overall picture. You need to understand what you want to get out, so they’re set up with that aim in mind.
CFO On-Call is a team of financial and business advisors working with open-minded people, committed to business growth and achieving success. For a copy of E-Book ‘The Seven Key Numbers that drive Profit and Cash Flow’, visit www.cfooncall.com.au.
