How do I find my Small Business Breakeven – Cash Flow Zero
Contributed by Idea Collective Member:
Small Business Owners! Do you ever feel like you are working your butt off in business but you don't have much money to show for it?
Of the hundreds of business owners I have worked with, this is all too common. But it doesn’t have to be.
If you are going to transform your hard work into hard cash, there are 3 levels of breakeven you need to understand for you business.
Here’s the deal. When it comes to small business, if you have passion for something, if you are put on this earth for a purpose, you can do it as a hobby or do it as a business.
So you ask yourself this question: Do I have a hobby or a business?
Answer: It all depends on your breakeven…all 3 of them.
Lots of profit (and cash!) “disappears” because we don’t understand our breakeven well enough.
Most people just look at the 1st or 2nd breakeven point but miss the 3rd…and will always have just a hobby as a result.
In my first article on Small Business Breakeven, we discussed the first level of breakeven, one I call the Charity Line. We decided that with very few exceptions (e.g. like promotional giveaways), you must NOT set your prices lower than Level 1 Breakeven. Otherwise, you are literally paying your customers to buy your product or service. A quick check of your profit and loss statement will tell you the answer. If your gross margin is negative, you are running a charity.
Let’s dig into the 2nd level of breakeven.
2nd Level of Breakeven
Your sales revenue covers all of your cash outflows. This is also known as Cash Flow Zero.
Why cash outflow and not cash expenses? Your accountant will tell you that some of the things you buy aren’t expenses right away. Inventory isn’t expensed right away. Equipment and fixtures usually aren’t expensed right away. When you look at your profit and loss statement you might be making money but it doesn’t mean you have cash in your bank.
Most small businesses don’t have the luxury of ignoring cash flow. This is even more true when we are experiencing inflation. Inflation just means that something will be more expensive to replace than last time we bought it.
Based on my last article, we made sure that each sale was covering the direct costs of that sale.
But wait! We also have costs for a cashier, rent, utilities, bookkeeper, website hosting costs, spoilage, shrinkage, and new inventory that is 20% more expensive than last time.
We have to get enough revenue to cover those expenses. Importantly, unlike direct costs, operating expenses don’t necessarily go up (or down) as the amount of our sales goes up or down.
Hint to get to Cash Flow Zero: Because many of these expenses are relatively fixed (not based on the amount of sales) they are more efficient the more we sell.
Here’s what we have to do.
- 1) Find your operating expenses each month. These are your other costs besides direct costs. Say they are $5,000/month.
- Include spending (cash outflows) that are not “expenses”. Equipment like computers and increased cost of inventory are two classic ones. Let’s say it is another $500/month.
- Take your total gross margin and divide that by your total sales. This is your gross margin %. Let’s say that ours is 50% (we sell a widget for $1 and our direct unit expenses are $0.50)
- Divide (#1 + #2) by your gross margin percent.
In the example we gave, ($5000 + $500)/50% = $11,000. We have to sell $11,000 worth of product/services to cover all of our cash outflows for the month.
Hurray! We got to Cash Flow Zero, which covers the money going out!
However, we haven’t paid ourselves yet for our time. And your time is valuable! So we need to get to level 3. This is what separates a business from a hobby.
Power tip for small business owners
Sometimes things get murky for many of us when we get our financial statements.
Our budget, business plan or annual goals might say “If we sell 100 of these workshops or 5,000 of these cupcakes, we will cover our expenses and cash outflows. (Cash Flow Zero)”
But then reality hits and we only sell 50 workshops or 4,000 cupcakes… and we reduced our price through discounts… and we had extra expenses we didn’t plan for. The sales target for Cash flow Zero is always moving around. We have to adjust quickly for changes in our prices, volume, and mix because they directly impact our Cash flow Zero.
The great news is that there are tools and strategies to manage this, but they AREN’T a traditional budget and a business plan, which become obsolete very quickly.
You work hard for your cash. I want you to keep it. I made this infographic for you. Please download it and start keeping more of your cash.
MKE's Small Business Coach
Focusing on micro and small business owners along with emerging entrepreneurs, Brent focuses on empowering entrepreneurs to find the money, means and mindset to unleash their business