Two Magic Numbers Every Business-Owner Needs to Know: Part 1
As accountants, you might expect us to see every number as important. But there are two numbers which, when used right, can provide some powerful advantages to business-owners. Over the next two weeks, we will outline how to identify two magic numbers which could seriously boost your decision-making and business insight. We also share how you can access free resources and discounted training sessions to get even more from those numbers.
Magic Number 1: Your Daily Break-Even Point or ‘I wouldn’t get out of bed for less than…’
Here’s a crucial question: Do you know what your business needs to sell every day to cover costs and pay you the income you need?
The answer to this will give you a key number for your business. Why? Because with it, your business decision-making is far more productive.
Uncovering your daily break-even point or ‘minimum level’ gives you greater insight into how to generate more sales – and how you use your time and resources. You may decide that once the minimum is in the bank, you can then increase your sales through incentives to increase the long-term growth of your business, by offering goods and services at cost. You may decide to reward yourself or your team with a rest or some time off! Or you may decide that you can invest some of the surplus in future growth through investments in technology or other resources.
Knowing this magic number makes it easy to stay in control without having to update your management accounts every single day.
Of course, the number will change over time as costs and margins change so you should review it every time you complete your management accounts. However, in the interim it’s a really powerful tool to help you to focus your mind on what you need to achieve.
How to calculate your own daily break-even point
- To start, you first need your latest accounts – preferably for a whole year to iron out any seasonal variations. Alternatively, if your business has changed a lot over the last year or is relatively new, it may be better to use your budget for the coming year.
- You should break down your accounts into three key sections – Turnover, Cost of Sales and Overheads. Your cost of sales should include the costs which increase in line with sales, costs specifically related to jobs i.e. direct labour, materials, delivery, internet selling fees etc. Your overheads will largely be fixed, regardless of your sales volume. Look through your costs carefully to check that they are represented in the right section
- Next, calculate your gross profit percentage. This is calculated as (Turnover – Cost of Sales)/Turnover
- Now calculate your daily overheads – this is calculated as Total Overheads/(number of Business Days in year). If you’re open 7 days a week 365 days a year, this is 365. If you’re open Monday to Friday each week, excluding bank holidays, this is around 250. If you work by yourself, Monday to Friday and take 4 weeks holiday a year, this will be around 220
- Now calculate what your daily income requirement is – Total annual income required/Business Days in the year. You now need to gross this up for taxes at your average rate, including NI if you are a sole trader
- Once you have these numbers, you combine them to calculate your break-even sales as (daily income before tax + daily overheads)/gross margin.
How it works for Fred’s business
That’s how to work it out. Here’s an example of how it can benefit a business:
- Fred sells goods on the internet and his gross margin is 25%
- His business overheads are £30k per year and the business is open 365 days – therefore his daily overheads are £82.19
- Fred needs an annual after tax income of £35k as a minimum and operates through a limited company paying an average tax rate of 20% – therefore his daily income requirement is £119.86
- His daily break-even sales occur at (£119.86 +£82.19)/25% = £808.20.
Fred now knows that once he hits this point each day he has covered his costs and therefore additional sales are the icing on the cake – this means that once this is achieved, his focus can change and he can afford to take a longer term view, he could offer some great discounts to attract new customers and win market share or he could give his existing customers an unexpected freebie to give them a reason to keep coming back.
Check back next week when we look at magic number 2 – The lifetime value of a customer or ‘a budget for dating’
Want to work out your own break-even point? We’ve created a simple spreadsheet tool to simplify these calculations. Enter your details here to request free copy now!