When people go into business it is important that they have a plan in place to ensure they are prepared for the likely pitfalls. A crucial part of this is a break-even analysis that shows how many units of a company's product must be sold to make a profit.
"It is highly unlikely that any business would make a profit in its first three years. However, it should be moving very quickly towards a break-even point as quickly as possible," says Mr Pat Delaney, director of the Small Firms' Association.
Achieving break-even means a small enterprise can be certain its business is viable, that there is a market for what it is producing and that its projections can be realised, he says. The three key factors for anyone managing a business relate to innovation, proper analysis and being action-led. Innovation is in the nature of anyone starting a business, but they are less likely to be analytical, says Mr Delaney. He underlines this as a core skill for business success.
"Sometimes small companies and owner managers will be surrounded by information and yet they don't have the capacity to properly analyse it," Mr Delaney explains. That's why those with accountancy and management skills, and the ability to use information to their best advantage have a better chance of success. "If you have analytical abilities, you are far more likely to succeed. So accountancy would be one of those key things - understanding the numbers, making sure they stack up or not and being able to use the analysis to inform your decision making," Mr Delaney adds.
Mr Jeff Delmar, a chartered certified accountant and business consultant, says that unless a company has experience in the area, break-even analysis is something its accountant will help it work out. He defines the process as benchmarking the minimum turnover a company needs to be able to afford to pay its overheads over a given period.
"It is quite crucial really because it benchmarks the amount of business you need to turn over, basically to break even - in other words not to make any money and not to lose any money. It identifies the minimum amount of business you must actually turn over to stay in business," Mr Delmar says.
He describes it as a very good yardstick by which managers of companies can benchmark how the company is performing on a month-by-month or week-by-week basis, if they don't have systems in place where they can do profit and loss accounts for the same period.
Break-even analysis is just as important for established businesses as their new counterparts. It remains a key feature, but is one that people tend to lose sight of, particularly if a company is expanding. For example, if a company that achieved a certain level of activity last year plans to expand this year, consequently more money will be spent. The company might think it is sufficient to reach the level of turnover previously achieved, but with increased overheads the break-even point will go up. That is why the figures need to be constantly re-evaluated and reassessed.
It can be argued that recent layoffs in large corporations have been directed at the goal of lowering the break-even point to increase profits. But Mr Delmar believes there are wider issues involved. Companies need to be careful that the people they are laying off do not restrict future activities. "If you lay off four sales reps - who is going to sell the product? You do have to be careful. It is not as simplistic as saying `if we reduce the staff overheads that means the break-even point comes down'. "You must be able to say that you have sufficient human resources left to sell the business."
A commercial enterprise needs to critically examine overheads to check it is not overspending in certain areas. Any reasonable-sized company needs to re-evaluate its break-even analysis at least quarterly, Mr Delmar suggests.
When a business is starting, it may take some time to rise to the break-even level, but it needs to prepare for this, says Mr Delmar. It must monitor its actual performance against its projections and make sure reality is closely tracking theory.
According to Mr Delaney, if - contrary to the business plan - a year after a company is formed, there is no progress towards it breaking even, it is highly unlikely it will achieve that goal in the future. Generally speaking, he says, it is after 18-24 months that a company starts looking to make a profit. There is no doubt that companies that fail in Ireland don't run out of customers, nor products or ideas. The stark reality is they run out of money. "Money is the critical lifeblood of any business," says Mr Delaney, "and the sooner profits evolve, the better."
Series concluded
