I often get asked how you can calculate a break even point for a business, but I’ve always believed that focussing on them can lead a business into serious financial difficulties. In todays video I discuss why.
Why break even points are dangerous for a business
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So you may have heard this, the saying where your focus goes, energy flows. And what that means is, if you focus on something, you’re more likely to achieve it. And the reason I wanted to do this video is when people focus on a break-even point in their business, then they are more likely to achieve that break-even point. I know a lot of people aspire to break even in the business, but actually, that is not a healthy goal for a business. What is a healthy goal for a business is to make profits, and enough profits to sustain a healthy lifestyle and quality of life for everyone involved in that business.
So just a little bit of background with break-even points. Typically, how a break-even point works is that, and a business owner will work out exactly how much money, how many sales they need to make, to cover their overheads, and at the point that they’ve covered their overheads, so the overheads could be things like rent, software that they pay for every month, accounting fees, their staff costs, and those are the overheads. So the idea is, you’ve got your sales, you’ve got your cost of sales, and then you’ve got your gross profit and then really to break even, what you’re trying to do is generate enough gross profit to cover your overheads. At that point, you are neither making a profit or a loss, and you have essentially broken even. So I think the idea of the break-even point is a very old school way of thinking anyway, because ultimately, what you’re doing is, you are then just focusing on survival.
Breaking even is about survival. But it’s worse than that because if you don’t factor in your own cost for living and what you need to take out the business to reward you fairly for what you do, then what you’re actually doing is you’re not even surviving. Your business might be surviving, and then you’re living off your own savings and your own other source of income to subsidize that business. But ultimately, you’re not going to get anywhere. So what is better than a break-even point is actually having a break-even point which factors in a healthy market value salary for yourself as an owner. So I know business owners often take a lower salary and take dividends, but whenever you are working out the break-even point, what you should really be doing is saying, “Okay, well, what am I realistically worth if I went and got a job and had similar responsibilities?” And then what you’ve then got to do is build the cost of that into your overheads.
And once you’ve done that, you’ve got your overheads, including a fair market value salary for yourself. And then that’s a better indicator of what you need to earn and what you need to sell and earn in gross profit to actually cover that overhead, including your pay. So if you are looking at break-even points, then what I would just say is just make sure you’re calculating it properly by including a market value salary for yourself. Otherwise, your business isn’t going to go anywhere. And the thing that you think will you get you to a break-even point is actually going to make you a loss in real terms, so when you factor in that you’re not going to get paid. So break-even points, if used incorrectly, can be very dangerous for a business.
But if used correctly, they can help you set a really, really good target. But yeah, as I said, just factor in your own costs when you do that. So if you need a bit more awareness about your finances, then we’re the people to talk to.