What's your company's breakeven point?

The figures on an income statement report the sales, expenses, and net profit or loss of a business. But these figures can be helpful in another way. They can be used to compute the breakeven point for the business. Knowing your breakeven point can help you run your operations more efficiently and profitably.

Simply put, the breakeven point is the sales volume at which the business generates just enough revenue to cover its expenses. While a business that's breaking even doesn't have a profit, it's not losing money either.

* How to determine breakeven. To calculate your breakeven point, you'll need to know three things: sales, variable costs, and your total fixed costs. Variable costs are those that fluctuate with the number of items sold, such as the cost of materials and sales commissions. Within limits, fixed costs do not fluctuate with sales volume (i.e., rent, insurance, and property taxes).

* Calculating the breakeven point involves two steps. First, it's necessary to figure out the amount left over from each sales dollar after the variable expenses have been subtracted. This is known as the contribution margin. Then the contribution margin is divided into your fixed expenses to get the breakeven point.

* How to use breakeven. How can you benefit from knowing your breakeven point? First, you'll be able to manage your business better once you know the sales volume needed to turn a profit. Second, by monitoring your sales, you can accurately predict whether you're on course to reach your profit goals. Third, you'll be able to take corrective action more quickly.

There are other benefits too. Using breakeven analysis, you can calculate the sales volume you'll need to cover the costs of a proposed new product or service. Plus, if you have a desired profit, you can add it to your fixed expenses and calculate the precise sales volume you need to achieve that targeted profit.

Call us if you would like assistance in using breakeven analysis to improve your business.

Business Planning during the Credit Crisis

The recent credit crisis is just a reminder of the importance and benefits of having a sound strategy that you can use to navigate through turbulent times. Don't hesitate to contact our office for objective guidance in helping you make intelligent financial decisions for the future of your business. In the meantime, below are some tips to help you assess your current financial condition and start re-thinking your business plan to face the current economic challenges.

1. Don't panic. It's difficult to make sound decisions if you do. To get a better sense of where you stand, begin by reviewing your cash position and anticipated cash needs. Are they in line with your business's short-term needs, goals and risk tolerance?
2. Take a fresh look at your monthly income and expenses. Have you been meeting your budgeted projections? How much of a drop in revenues can your business withstand and for how long? What are your cash-flow needs for the next 90 to 120 days? Or 120 to 180 days? Do you have sufficient cash reserves for the next 30 to 60 days?
3. Check with your lenders on the status of your credit lines. Are you in compliance with their terms? Will your bank renew their commitments at similar amounts, rates and terms?
4. Eliminate your reliance on credit by disciplining your spending.
5. Refocus on your balance sheet and how much credit you are extending to your customers.
6. If your credit lines are frozen or at their maximum limits, consider meeting with vendors and working out a schedule of partial payments that would allow continued delivery of critical materials and supplies.
7. Look into alternative types of financing. Some to be considered are loans on life insurance policies, loans from key customers that rely on your business for their materials and supplies or from labor unions, local development agencies or the U.S. Small Business Administration.
8. Keep an eye on your accounts receivable. Watch for new patterns of slow payments and follow up immediately. Review your largest and riskiest accounts to determine whether credit constraint or economic slowdown will affect their ability to pay you. Keep receivables aging current at all times.
9. Manage accounts payable more closely. Forfeiting early pay discounts may be more advantageous in preserving cash that may be needed for critical items. Keep payables aging current at all times because that's an important tool for managing cash.
10. Analyze your expenses and determine which ones can be controlled. Can you reduce spending in any areas to put less of a burden on your cash-flow needs? As necessary, communicate to staff/team members about the need to tighten spending. If you are a manufacturer, review inventory management practices. Are there opportunities to reduce your on-hand inventory? Service companies should make sure they're capturing all their billable hours and invoicing promptly. Have you billed all your contractual items? How about all your pass-through expenses, such as billable third-party services and travel and living expenses?
11. Consider ways to pass your increased costs (i.e., fuel expense) on to your customers.
12. Check the safety of any cash deposits you have. On October 3, 2008 the FDIC deposit insurance was temporarily raised from $100,000 to $250,000 per depositor through December 31, 2009. If you have more than $250,000 in any one bank, move the excess to another FDIC insured bank. Consider investments such as CDARs (Certificates of Deposit Account Registry) to spread the risk of short- to medium-term cash you may have invested in CDs.
13. Don't engage in panic selling of your investments. Make sure your portfolio is diversified and in accordance with your risk tolerance.
14. Come up with a plan NOW to respond to future declines in revenues, before they actually occur. Re-think your business strategies and update projections. Review your product/service lines to identify the most profitable items and determine how to leverage for future growth in profits.
15. Contact your good customers. Even casual discussions can lead to new business opportunities.
16. Review all your insurance coverage, particularly any from companies with weak balance sheets. Be careful not to surrender a policy, as securing new coverage might require underwriting that can affect your coverage.
17. Calm your employees' fears about how this crisis will affect the company, their jobs and their retirement or other benefit plans. Speculation and gossip are counterproductive, so it's better to address their concerns directly.

Finally, remain focused on your own advantages. Remember that:
* Small businesses have greater flexibility and can more easily adjust to changes in the economy than their larger counterparts.
* Small business owners can use the recent crisis as an opportunity to buckle down, refocus, assess and make their company more financially sound, disciplined and less reliant on credit.
During tough times, it's important to maintain communication with our firm, your trusted adviser. Remember that you are not alone. We know and understand your business and the challenges you face, and we can work with you to navigate these turbulent times. We can help you gauge your current situation in the wake of recent market events and create a sound business plan in response. Contact us today for expert advice on how to maintain your company's success.

Making Sense of your Financial Statements

Financial statements provide an overview of the economic situation of a business or individual. While many small business owners often keep themselves busy well beyond an eight- or 10-hour workday and "live and breathe" their business, the nuts and bolts facts of their financial condition are often overlooked.

With increased scrutiny of financial documents for even closely held companies, financial statement analysis and forecasting programs are an excellent resource for owners of businesses. Use of such tools will help the owners gain a better understanding of their present and potential financial condition and can ease the process of acquiring additional funding, whether through loans or private investors or provide insight to how well the company is performing against its industry peers.

Several ratios can give insight to a companies performance. In the following article we can explain the liquidity, efficiency, operating, financing, and profitability ratios.

Liquidity Ratios

Liquidity is a company's ability to meet its maturing short-term obligations. Liquidity is essential to a business when confronted with unforeseen events, such as a strike, recession, supply interruption, and so forth. Favorable liquidity is also necessary for taking advantage of certain business opportunities that may develop. Determining the liquidity of a company is particularly important to creditors, since it may affect timely payment of principal and interest payments, and payment of trade debt, as well as overall solvency.

From the firm's perspective, the liquidity ratios measure the management of working capital, which includes activities with current assets and current liabilities.

Working Capital to Sales Ratio is computed by subtracting current liabilities from current assets (equivalent to calculating working capital), and then dividing the result by net sales. This measures the working capital a company is carrying relative to its sales volume, and is an indicator into how much working capital is required for a certain sales level. It also provides insight into the degree of protection afforded current creditors.

Although there are differences of opinion, it is generally accepted that the higher this value the better, because it means that the company is doing a good job of creating working capital for day-to-day operations and to guard against any sudden downturns in business. Extremely high values, however, may indicate that the company could be generating higher sales with the available working capital.

Efficiency Ratios

Efficiency ratios usually indicate how well a firm is managing its accounts receivable, accounts payable, inventory and operating cycle. Because these ratios are based upon a snapshot of certain balance sheet accounts (to total annual sales), they will not reflect seasonal fluctuations.

Days in Accounts Receivable is defined as the average number of days required to collect an account receivable. The ratio is calculated by dividing (Trade) Accounts Receivable by average Daily Net Sales and is expressed in days. Firms should strive for a low number of days in accounts receivable, because it means receiving payments quicker and enhancing cash flow.

Accounts receivable turnover is sometimes used as another benchmark in this area, and is defined as Annual Net Sales divided by Accounts Receivable.

Operating Ratios

Operating ratios are designed to assist in the evaluation of management performance and its effectiveness in utilizing the resources available.

Asset Turnover is calculated from Net Sales divided by Total Assets. This ratio measures a firm's ability to generate sales from the total asset base. Higher ratios suggest a greater capacity to create sales with given assets. This ratio is particularly helpful in conjunction with other asset utilization measurements.

Financing Ratios

Financing ratios analyze the relationship between a firm's debt load, its fixed asset base and net worth. Essentially, they explore the financial structure of a company.

A high level of debt can make a firm vulnerable to business downturns for reasons beyond the firm's control. Two ratios are commonly used for this analysis: Debt to equity and cash flow to current maturities of long-term debt.

Cash Flow to Current LT Debt Ratio is computed by dividing Cash Flow (as measured by net income before taxes plus depreciation, amortization, and depletion) by Current Maturities of Long-Term Debt. This ratio provides insight into how well the company is able to meet its current obligations on long-term debt through its cash flow. The higher the value, the better.

Profitability Ratios

Profitability ratios are useful in expressing the company's earnings relative to what created them, whether it is sales, owners' equity, or total asset base.

Return on Sales (Net Profit %) measures a company's ability to generate profits relative to the sales volume. It is definitely one of the key indicators of the success of a business. Return on Sales is calculated by dividing Net Income before Taxes by Net Sales, and expressing the result as a percentage. Obviously, the higher the value, the more successful the company is at generating profits from its sales.

In short, business owners need to be able to identify negative and positive trends. They need to know not only if cash flow is dropping, but why, and how to increase it before it dries up completely. We can help you with a complete review of your financial structure to give you ideas of were your company stands against the industry and what actions plans could be taken to improve performance in some areas. As always, if you have any questions or concerns please contact our office.