Talking about breakeven

Show notes

• Watch the infamous Dragons on the BBC
• The promised information sheet will be coming soon to the Free business tips and resources page.

 

About today’s guests

Julie Stanford:  Talking about breakeven. There’s no more fundamental dividing line in business then a company that makes a profit and one that makes a loss. I’m Julie Stanford, and a while ago I presented a radio show for RadioReverb in Brighton. What my guests talked about then is still really relevant today. On this show my guests are Julia Chanteray, Paula Tomlinson, and Paul Jordan. We talk about breakeven and why it’s so important to your business and your sanity.Welcome to the three of you. The reason I’ve invited you all here is really to talk about … I mean I was actually initially going to say let’s talk about breakeven, because it’s such an important thing for businesses, A to understand, and B to use in their business. Then I’ve sort of I think lost confidence and thought, “Is that going to be an entire show? Possibly not.” In which case I will really listen to your better judgement to think about are there any other areas of business that when you’re working with the businesses in your day to day lives that you’re finding that they’re struggling with. They’re not really understanding, but you are all thinking that they’re quite important aspects. Perhaps it might be a good idea if we kick off. Paula if you wouldn’t mind just explaining exactly what breakeven is. Can you use words that I’ll understand please?

 

Defining breakeven

Paula Tomlinson:  Of course, I like to think of it as a pivot point really, below which you make a loss, and above which you make a profit. It’s a point at which your costs are covered. Those costs need to be, what’s called your fixed costs, which would be say rent or staff costs. Also the cost of the product that you’re selling. Now for some businesses there isn’t much of a cost of the product they’re selling, so it’s less relevant. If you’re kind of a market stall holder and you’re buying and selling apples say, you’ve got the rent of the market stall. Then you’ve got the price of the apple, and then the price that you’re selling the apple at, the cost of the apple and the price you’re selling at. There’s a point there you got to cover the cost of the stall, and make sure that you are making a profit on the apples. You’ve got to see at what point do you cover the cost of that stall with the profit that you’re making on the apples.

Now the point of doing the calculation is that you can then establish that your pricing is correct, either that your costs are correct, or the cost of the apple, or the price that you’re selling it at is correct, so that if you’ve got it wrong it might point out to you that actually there’s no way that you could sell five hundred apples in a day in order to cover your costs, and there’s something wrong in the whole equation. You’ve got to kind of revisit all the numbers that make up that calculation that you did. We’re not talking a complicated calculation. It’s just bringing all the facets of your cost base and the pricing that you’re going to pitch, and to make sure that that covers all the costs.

Julie Stanford:  When you use that example of a market stall holder selling apples, you think, “Okay I get that. That seems quite sensible.” I can see that nobody would want to be selling their apples at a loss, and nobody would ever think they could sell five thousand apples in a day, or whatever it is, but then it becomes more complicated doesn’t it. Because for those of us with a service or those of us who are buying, are creating a product that then we’re selling over maybe two years, it becomes a bit more awkward. Julia, is it something that you work through with your clients? Because it’s such an important thing that they need to understand. Do people understand it usually?

Julia Chanteray: I think sometimes people understand it at very basic level. They’ll say, “Are we making any money?” That’s one of the most basic things that you automatically are going to ask yourself in business, “Have I got enough money coming in to pay the bills?” Sometimes people don’t even get to that point, and that becomes very worrying, but most people can see that. When you’re running a business which is a little bit more complicated, so say there’s a business where you make a product, and you spend a year making that product. You’ve built some software, you’ve published some books maybe. Like Julie publishes some books. It takes you a chunk of time to do that product. Before you’re selling it you’re not making any money, so you’ve got to take into account all of your overheads, your offices costs, the cost of your pens, your stationery, your staff, all of those things, and take those into account when you’re calculating your break even point. See at what point will I be able to sell enough apples, or pieces of software, or books in order to cover that period that I’ve had to put money into the business. Then think, “Am I going to be able to sell enough of this to make it worth my while over that period where I’ve had to make the product? Am I going to get my money back that I’ve put into my business?”

Julie Stanford:  I can remember the thing that used to really confuse me was the timing aspect of it. When I first started I used to think, when I first started making a product I used to think what length of time of the cost of making the product. In other words, if it takes me seven months to put one of the guides together, which it does. I’ve got writers and photographers. Then I’ve got printing. I mean printing is easy because I know how much per book, but I found it really difficult. I mean obviously Paul you’re going to be working with companies who are making things, or they’re selling services. How would you approach it with them? Do most businesses in your experience know that they need to understand breakeven?

Paul Jordan:  I think they do. It just depends on what you’re going to use it to do, to demonstrate something. Particularly in the sorts of companies that you meet at the Innovation Center it’s important to know that if you sell something for five pounds you get three of those pounds after you’ve covered the cost of traveling, or the cost of making the product, or whatever it is. Those costs which only occur if you make a sale. The fixed costs occur whether you make a sale or not. You wake up on day one of a three hundred and sixty-five day year facing a lump of cash. You might as well get used to that. When you want to prove at what stage in the year you break even, you know you’ve literally sold enough to cover those costs from day one.

Julie Stanford:  I think there are certain things about business that I feel, I know I felt this myself, so maybe I’m projecting onto other people, but I have heard this said by others. For instance, when I published the Essential Business Guide people would read this and say, “If I had read this I wouldn’t have started a business.” Which worried me slightly. I think, do you find that with your clients Julia and Paula that you, they don’t want to know sometimes because it’s putting down on paper how profitable or not profitable the business is. You can’t avoid that calculation. Sometimes you might look at that as a business owner and think gulp, “I don’t think I’m charging enough. My cost is too high, or I’m selling the wrong thing.” I’m speaking from bitter personal experience.

 

Thinking about your profit

Paul Jordan:  It’s a real hoary chestnut because people don’t start to make a gross profit margin of X, or you know a lump sum of profit of Y. Generally they start probably because they are passionate about what they do, and they feel they want to try and earn a living for themselves I guess. I don’t know whether that’s a common experience. You know you’re very lucky if you find that you can actually make a lot of money out of your God-given talent if you like.

Julie Stanford:  Julia, if you’ve got those businesses who are feeling like that, how do you get them from that point of, “I love what I do and I don’t want to hear the cold facts about my profitability.” How would you deal with that? Do you hit them over the head with the calculator, or do you ease them gently into that notion?

Julia Chanteray: I think that as Paul says people’s motivation in going into business is not necessarily, “I want to make oodles and oodles of money.” For some people that’s what they want to do, and good luck to them, on they go. Most people that I work with that’s not necessarily their primary motivation. They want to make a decent living, look after themselves, their family, pay their mortgage, et cetera, but they’re not necessarily going for mega bucks. What I need to do is to encourage them to go for at least a chunk of the mega bucks in order to make sure that the business will survive the bad times as well as the good times. Also because having some money gives you options. If you’re making more of a profit, if you’re above breakeven point, it gives you options about what you’re going to do. It gives you some cash reserves if you want to go and diversify into a different product, and do something different. It gives you the chance to act a bit more like a social enterprise and give some money to charity. If you’re not making any money you can’t give it away. I have to appeal quite often to people’s other motivations in order to nudge them into making a decent profit margin, yes.

Julie Stanford:  I don’t know Paula whether you have this experience that, I mean I’m talking about it as if it’s a negative scary thing, but it’s also very exciting. Because if you see that you are very profitable, and at that point you’ve covered your costs, and things that you are into profit now. That’s exciting as well isn’t it?

Paula Tomlinson:  I think yes absolutely. I think information is power. It does empower you when you’re running your business to know that you’ve met that target, and that the rest is extra for you. I think it’s good for a business to just go through the process. I mean even if the calculation turns out to be slightly wrong. I think people do get a bit hung up really about the exact calculations and all these ratios and things. Actually if you sort of just have a bit of an idea and you revisit regularly, and you just go through that process of saying, “Okay this is roughly the sort of number I’m looking at.” You must feel a lot more comfortable about your day to day activity, and where you’re heading. I do think it’s important to aim beyond breakeven and even beyond that. Because when things do go wrong you can be the one in [real dire straits 00:10:57] and your whole business can go under. You need that margin of error, absolutely, as Julia was saying.

Julie Stanford:  Actually I was just, as you were saying that, thinking something that somebody once told me. Then I realised it was Paul who told me this years ago. That if you’re not in profit, and you’re not working to make a profit, then it’s more like a hobby really. We can all do our hobbies, but keep them away from whether we’re going to potentially go into debt, or lose our houses, or whatever the painful thing might be if the business doesn’t work. I’m wondering whether it might be an idea for us to do a handout. Which I can put on my website about how you do this. Because one of the things with the Essential Business Guide I wanted to say, “One do that, two do this, and three do that.” Because I have this need to reduce information down to an understandable way, but it’s not that simple, is it? Even though I’m hoping that you will be able to make it that simple.

Paul Jordan:  It depends on what your business is. Essentially you’re not alone. When you’ve created your professional team you’ve got an accountant hopefully, you’ve got a lawyer. An early conversation with your accountant will begin to focus on the content of what your gross margin will be made up of, and where your variable costs are coming from. Just to finish off that bit about fixed costs. It’s possible for you to do an assessment of what you need from your business. It almost goes back to setting personal goals for what the business has to do for you. If you have young children they will grow up and go to university, and you will need to pay for that. If you don’t have a pension you will need to make a contribution. If you need to replace your computers every five years you will need to put money aside to do that.

The calculation of this fixed cost at the beginning, whilst it seems a bit scary, needs to cover more than the rent, and the rates, and the property, and the way of delivery. That’s often an area that is left to chance. It’s a surprise if you’ve actually got surpluses to cover. Confidence, as you’ve been saying, is all. You’re not really going to get too heavily into that in the early stages.

Paula Tomlinson:  I think people sometimes don’t like to embark on these exercises because it raises questions for them that they’ve then got to deal with.

Julie Stanford:  Yes, go on Paula sorry.

Paula Tomlinson:  It sort of opens up that box, doesn’t it? That people like to kind of put to one side a bit, and just hope it goes away.

Julie Stanford:  I was saying that to you Julia that I think that some of us, it’s easier not to know, but actually you have to know. Because otherwise you’re not running a business in the way it could be run for your greater good if you see what I mean.

Julia Chanteray: Absolutely, and people like to bury their head in the sand a little bit. A lot of the people that I go to see about their business the financial part is the part that they haven’t planned out so well. It’s not seen as the sexy exciting bit. It’s just sad people like me that find the spreadsheets to be funny, or exciting, maybe not sexy. I wouldn’t want to go that far.

Julie Stanford:  That’s not what they say about you though Julia.

Julia Chanteray: My spreadsheets are sexy. It’s very easy to hide away with all of that, and to not think about it. When that comes up, and it will come up when you get a tax bill in, and you haven’t put your money away for the tax bill. You think, “Oh corporation tax, never thought about that.” If you’ve got suddenly a supplier that changes their payment terms, and you’ve got to pay them more quickly, and you’ve been used to paying them on thirty days, and suddenly they want paid on delivery. Those things, you’ve got to be able to plan for those things. If you haven’t planned it’s going to bite you on the bum.

Paula Tomlinson:  I’ve had a client with that corporation tax problem. They left their previous accountant because they felt that they hadn’t been looked after properly. They said, “We’ve got tax to pay, and I don’t know what to do about it. I have no money.” They had spent the money.

 

Misuse of overdraft

Julie Stanford:  It’s a terrifying position. The other one is, I’ve known a number of businesses whose overdrafts were recalled, as the bank has a right to do. Now that’s a scary moment I think. Because at least with the tax you can ring and say, “Actually I don’t have the money. Can I have a payment schedule? Could we do it this way?” If the bank, Paul you’re looking at me in a very quizzical way, and you may have had experience of this when you were working in the bank you were involved in. It can be done. Banks are allowed to do that, aren’t they?

Paul Jordan:  Yeah, on demand facilities should be clearly stated, and there should be documentation to say exactly what you’ve got. I think you have to start by saying banks have a checkered history by reputation. I have certain sympathy for the use of a particular product and what it’s for. Overdrafts are supposed to go into credit. In theory they’re supposed to be backed by a projection of cash flows, why they’re needed in the first place. If you plan to grow your business and get stronger you might think about getting rid of it as quickly as possible, and building reserves that provide you with this loose term working capital.

Julie Stanford:  And the buffer.

Paul Jordan:  The buffer, historically, and it’s eight, nine years since I did this for a living, customers would draw all of their profits out of the business year on year on year. When the business was growing and they needed more money they would seek more overdraft facilities. Then if the business was failing you would see that in the overdraft because there would be areas of debt that never changed. Tremendously inefficient for the client who never paid off their debt, and had an overhead cost each year, and an arrangement fee, and all those dreadful things. These things are never, you know there’s no smoke without fire. If banks withdraw overdraft facilities they probably have a reason for doing it.

Julie Stanford:  I think the thing that’s interesting to me though is the perception of that overdraft facility by the business owner. Julia and Paula you must find businesses who seem to think that that’s okay to do that. To stay right up at the limit of the overdraft, to use it willy nilly, without thinking of it as a support for the business. As you say, which you’ll go in and out of credit.

Paula Tomlinson:  It’s supposed to be temporary, isn’t it, to deal with fluctuations?

Julie Stanford:  Yes, where as most people think it’s just another way of adding money to the business. That’s the problem. Those overdrafts are likely to be withdrawn, or could be. Then you’ll have a business owner who didn’t know that was going to happen because they don’t know where they are in the whole process of the finance. Not the process, but you know what I mean.

Julia Chanteray: Some businesses stay for years and years and years at the level of their overdraft, and they’ll be just under their limits. Just up to their limit, just under their limit. Their account will never go in credit. If those businesses took the time to add up the fees that they’d paid, and the interest that they’d paid to the bank, then they’d probably see an awful lot of money which could have been in their pocket, could have been profit. That they’ve just paid to the bank. I’d rather see the money in the pocket of my client’s than in the bank’s pocket.

Julie Stanford:  As advises to businesses you must feel that because you have an understanding of finance. You have an understanding of planning the money, of knowing where things are, knowing what your breakeven is. It must be quite frustrating for all three of you when you see someone not taking notice, or not using their money in the best way.

Paula Tomlinson:  I think that people get into a rut, and they carry on doing the same thing they have done for years. It is hard to pull them out of that, very hard. You do have to latch onto what they’re interested in. Sometimes things in their life change as well, which is another reason for them to listen to you. Maybe there are university fees coming up that they haven’t foreseen, and it’s suddenly, “Oh dear I’ve got to be a bit more serious about my business.” They might not foresee it, but when it does come along then you can help them out there.

Julie Stanford:  Given that broadly we were really going to be talking about these areas of finance that we think business owners need to be aware of, and need to have the answers for, so breakeven is one of them. I mean you touched upon gross profit margin, which obviously is another thing that people need to know. Anything else that come up time and again for you that you find yourself having to explain, and wishing that business owners would listen to you when you talk about the importance of them?

Julia Chanteray: Number one is planning your cash flow in advance. Cash flow is the number one killer of businesses. It’s again about what we were talking about with the overdraft, over reliance on the overdraft, which may or may not be there. Especially with the change in the way that the banks look at lending to businesses. We’re seeing quite a lot of that with those changes at the moment. Where companies thought they could refinance and they can’t. Looking at cash flow in the same way that you look at, “I’m going to the pub tonight. Have I got enough money to buy a round?” You don’t want to be getting your mates to buy your rounds for you all night. Because that’s not going to make you a popular boy or girl. It’s the same thing with looking at your business finance. Making sure that there’s enough money in the bank now to pay the bills that are going to come up next week, and next month. If you haven’t got enough money to pay next month’s bills where is that money going to come from? Making sure that you bring the money in now and that way you’ll have a successful business, and you’ll always have some cash to go down to the pub as well, or whatever else you want to do.

Julie Stanford:  And buy lots of rounds.

Julia Chanteray: Yeah, absolutely, then I’ll be your friend.

Julie Stanford:     Paul what would you think? You’re advising lots of businesses, are there areas that you think, “I wish they’d really listen to me because I know how important this is.”

Paul Jordan:  Depending on the role that I’m undertaking or have undertaken in life, it’s changed for me. The Innovation Centre is very much about strategy and marketing, and market analysis, and deep understanding of markets before you step into them, and planning your particular approach. I quite like the writers who talk about starting your own business and realising that you’re not creating a job. You’re creating a business, and that’s different. Getting that mindset right, and these others things are tools in your kit bag to deal with things in the same way as if you were buying materials and making them into something. You need the knowledge to be able to touch upon them. You need support and expertise around you when it gets a bit tough and you need to talk about them. If you ignore them then it may come as a surprise to you as your business sort of drops away, but you won’t have lost any sleep because you won’t know about it.

Julie Stanford:  Paula, using that analogy of the tools in your kit bag, when you’re advising your clients and in your role as a charted accountant as well, you must have constantly had people that you wanted to hit over the head with the accounts. I’m just guessing.

Paula Tomlinson:  Well I think we’ve covered, breakeven point I think is really important. The cash flow planning I would agree is one of the most important things. Then the gross profit margin as well, because that’s a good indicator as you’re going along if things are dropping off, if you’re under pricing it, under pricing your service or your product.

 

Final breakeven tips

Julie Stanford:  I’m definitely going to get the three of you to do, just to help me with an information sheet which I’m going to make available for people so they can work out how to do these dark art. I always talk about them as a dark art, but it feels like one to me. I’d like to end this round table discussion by tips, as you know, those of you who have been with me before. Just a thought you have, or a tip, or a suggestion to anyone listening about a way, something they should be doing, or a great idea for their finances. Not other than going down the pub Julia and spending it all on a round. Paula, what would be your tip? Someone listening broadly about breakeven if possible.

Paula Tomlinson:  Be realistic, I think you know just don’t be afraid of sitting there and writing these things down. It’s logical. A lot of it is really logic at the end of the day. They may have certain names, and phrases, and labels, but it’s irrelevant. You know just think sensibly is about more money in than the money going out. It’s all playing around with that, so just be realistic. Face up to the fact that you’ve got to pay money out for rent, or staff, or something. Just face it, and then think life gets a lot easier.

Julie Stanford:  As you said information is power.

Paula Tomlinson:  Yes.

Julie Stanford:  In business it is power isn’t it? It’s quite a liberating thing once you know exactly where you are.

Paula Tomlinson:  Definitely.

Julie Stanford:  Because at that point you can then change it if it needs to be changed, or celebrate if you find that you’re actually doing brilliantly. Paul, what would be your tip for listeners?

Paul Jordan:  Give yourself some time to prepare, and do the research. It’s hard yards, but it will pay off in the end. Take the advice, there’s advice around at all sorts of levels. If you’ve got people who can help you, find a mentor. Talk to somebody who has experience and knows about it, invaluable.

Julie Stanford:  That’s true, someone who’s walked the path ahead of you. Julia, as someone who’s walked the path ahead of all her clients, all of you have.

Julia Chanteray: I think I’d add something to what Paul’s just said. If you don’t understand what these strange terms are don’t be scared of them. Because it’s not rocket science. It’s not that difficult. They’ve just got some funny names, like Paula said. If you can run your own household budget then you can run your business budget. You need to understand some of these things. Don’t be scared to ask questions. Don’t be scared to ask your accountant, to ask a business adviser, to get somebody to explain those things to you, so that you’re in command. When people use words like depreciation, or gross profit margin, remember that those are always the things that on the TV show Dragons’ Den people get caught up about. Because they don’t know the numbers. You see their faces just go completely blank, but make sure you know what those things are. Find out, take responsibility for finding out. You’d find out things about your own product and be able to answer questions about that, so find out about the money side of your business as well.

Julie Stanford:  It’s interesting that listening to Dragons’ Den they were talking about burn rate. I realised that after twenty-five years in business I’ve never heard that saying. I’m sure everybody uses it, but I’ve never heard it. My brain was scrabbling to catch up thinking, on Dragons’ Den, “Burn rate, burn rate, what does that mean?” Of course it’s obvious what it means, but it’s ridiculous that you can go this long without hearing a particular saying, but you can. Hopefully people will have heard lots of sayings today: depreciation, breakeven, the dreaded gross profit margin. Hopefully I’ll be able to put a sheet together on the website to help them work out what it all means.

This show was originally recorded for Business As Usual on RadioReverb. I’m Julie Stanford. Thank you for listening to Essential Business Radio.