Business plan

How profitable will my business be? Start with a break even analysis

falling moneyIf you are planning to manufacture or create a product, you will need to do a “Break Even” analysis. The point of this is to find out at what point your sales (sometimes called receipts) will cover the costs incurred and when you can expect to start making a profit.

This is an important exercise and will help you see if your business idea is viable. For example:

O number of sales = you are working at a loss and could end up in trouble
X number of sales = pay your bills
XX number of sales = pay your bills and make some money

We can project the costs of the product we are going to make and the amount of the sale we expect to achieve when that product is sold.

The point at which sales covers costs is called THE BREAK EVEN POINT.

To find this point, we need to recap on some of our accounting terms:

FIXED COSTS = the costs which stay the same regardless of what work we do and how much we produce. Examples of this would be rent, rates, fixed salaries, etc.

VARIABLE COSTS = the costs which vary with the amount of output. Eg: Eggs cost 6p each. If we need two eggs to make one omelets our variable cost will be 12p; we need four eggs to make two omelets so our variable cost to produce two omelets will be 24p, etc.

Now consider the following restaurant, Charlie’s Chattery.

It has fixed costs/overheads of £15,000.

The chef makes one omelet with a variable cost of 12p. It is sold for £2.50. The difference between the SELLING PRICE and the VARIABLE COST is £2.38. This is called a CONTRIBUTION. And each omelet sold will make a similar contribution – which goes towards meeting the FIXED COSTS.

Use your calculator to check these figures……Charlie’s Chattery needs to cover £15,000 of fixed costs. £2.38 divided by £15,000 is 6302.5. This will mean it has to sell 6302.5 omelets before BREAK EVEN is achieved.

ONLY THEN will it move into PROFIT.

Any omelets produced over and above the 6302.5 that are needed to meet the Fixed Costs are known as “THE MARGIN OF SAFETY”.

If costs rise (variable ones) you may be able to pass them onto the customer. i.e: Variable Cost rises, Sales price rises at equal rate.

However, if competition means we have to reduce our sales price, the break even point will reduce and we will have to sell more (each item giving a smaller contribution to fixed costs) to reach the break even point.

This is not a calculation you should do only during initial business planning; knowing your product and careful planning will mean you are ahead in the market place; it is hard work being self employed and often even tougher when you are disabled, so protect yourself and your business with regular reviews of your costs, sales and competitors. This means that changing trends will not catch you unawares and you will have the opportunity to take positive action to maintain your level of profit.

Will I survive going into business? – better do a survival budget

piggy bankProducing a Survival Budget is a vital part of preparing for your Business.

Do you get to the end of the week and wonder where your money has gone? Or receive a bill and wonder how to pay for it?

By completing a Survival Budget honestly, you will be taking a good look at your personal finances and may see ways to reduce your outgoings. You will find out just how much money you need a year to live; it will also show you how much your new business will need to earn to make it a viable proposition for you.

Complete all sections and complete them honestly. For example, if you are chocoholic and buy three Mars Bars a week at 45p each, this would total over £70 a year – and a lot of calories! Whilst this may not seem a lot on its own, repeated a few times, the total soon adds up.

If you are currently receiving Housing or Council Tax benefits, you need to put the full amount of rent and council tax payable in the Survival Budget, as once you start trading you may lose these or have them reduced. Put the benefits you receive under “Income” at the end, so that you can see if you are solvent with your present income.

There are four columns in the table. The first lists all possible reasons to spend money; you may need to write in additional categories to personalise it.

The second is for any weekly expenditure, e.g. papers, housekeeping, etc. Once you have entered a figure here, multiply it by 52 and put the total in the fourth column (showing your annual expenditure).

The third column is the “per month” column. This is for amounts that you pay monthly, for example Direct Debits. Enter the figure in this column and then multiply by 12. If you pay Council Tax or Water Rates by Direct Debit, you will need to multify them by 10 to account for no payments being made during February and March.

The fourth column is the “per annum” column. This is for annual payments (e.g. Insurance or a Subscription) and for all the other payments that have been multiplied up to reflect their yearly total.

Add the “per annum” total carefully and this will show you what you spend each year.

Under “Income” work out how much you receive per annum. If you are working, you should put the Net figure you receive in the columns.

Now look at the information this gives you.

Is total income more than total expenditure? If so, are you saving money? If you are not, where has it gone? Did you spend it on something that is not accounted for in the budget? Was it a “one-off” expenditure, or could it happen again. If it could happen again, you need to add it to your expenditure figures.

Is total income less than total expenditure? If so, you are probably overdrawn at the bank and/or living on your credit card. This may not be the best time to start self employment as the benefits you are receiving may be reduced and your business may not pay you much to start with. Can you consolidate your debts in any way or reduce your expenditure?

Next is a separate sum. Look at your current income and add together any income that will definitely NOT be affected by your earnings; this may be such things as another wage earner in the family or your DLA. How much do they total per annum? Now look at the difference between this figure and your total annual expenditure. This is the minimum profit that your business will have to earn to support you. Divide it by 12 to see how much you will need to earn a month. This figure will need to go into your Cash Flow Forecast as “drawings”.

Download your sample Survival Budget now in either Word or Excel.

Note: If the annual figure is more than your Personal Tax Allowance your business will need to earn more than your basic Survival Budget shows to allow you to pay your Income Tax and National Insurance.

 

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