Understanding The Most Important Number In Your Business: Breakeven

Let's talk about the one number in your business that matters more than almost anything else: Breakeven.

Whether you like it or not, if you're a business owner, you need to understand this beyond the typical textbook definition.

Here's the official definition if you need: Breakeven means to make no profit and no loss. Total money coming in equals total cost going out. You cover all your expenses, but you gain no extra money.

Sounds simple, right? But I'd bet if I asked you right now whether you know your breakeven point, a lot of you would have to stop and think about it... and that's the problem.

Business Owners Make Up Their Own Definition
Business owners create their own definition of breakeven that has nothing to do with accounting.

They think their breakeven point is "do I have any money left in the bank account at the end of the month" or "am I going backwards with my cash."

We actually ran a Know Your Numbers workshop recently, and when we asked business owners if they knew whether they'd been profitable last month, almost everyone said yes.

But when we dug deeper and asked, "Are you basing that on your profit and loss statement, or are you basing it on your bank balance?" nearly all of them admitted it was the bank balance.

That's a problem, because relying on your bank balance to judge profitability is one of the most dangerous habits a business owner can have.

If you're breaking evens but you've still got cash going out the door for drawings or loan repayments, you are going to run out of money. 

Breakeven Isn't Something to Be Proud Of
I want to be really clear about this: breakeven is not a goal.

We're not in business to make a big fat donut. We want to make a big fat profit, pay some tax on it, and be proud of that.

If your business is sitting at breakeven, that means you've worked incredibly hard for zero reward.

What Breakeven Point Actually Looks Like
So how do you actually calculate this?

Breakeven point is the value of sales monthly, quarterly, or annually at which you breakeven at your assumed average gross profit.

Say your overheads are $250,000 a year. That means you need to generate $250,000 of gross profit just to cover those overheads and land at zero.

If your average gross profit margin is 50%, then you need to sell $500,000 worth of stuff, because 50% of $500,000 is $250,000.

Once you know that number, translate it into something tangible for your world.

• How many units do you need to sell?
• How many hours do you need to work?

If you're on an hourly rate, you might quickly realise there aren't enough hours in the world to hit your number, which tells you that you need to move to a value-based pricing model instead of $150 an hour.

The $50k Sales Month Story
I was talking with a business owner recently who's genuinely one of the top 5% in the country when it comes to knowing their numbers.

They do 90-day business planning with us, they study their cash flow religiously.

They told me it used to be that they aimed for a $50,000 sales month, and they knew that if they hit it, they'd have a decent profit.

As they've grown and taken on more people, their wage bill and overheads have gone up, so now they know they need $50,000 of sales every month just to cover costs.

They didn't use the word "breakeven," but that's exactly what they were describing.

Now they're having $100,000 and $110,000 months, and the profit and the cash sitting in the bank reflects it.

Breakeven for Cash Flow Is the Danger Zone
It's one thing to be breakeven on your profit and loss, but it's another thing entirely to be generating enough cash to service your balance sheet.

If you've financed a big piece of equipment, say a CNC machine through a finance company, those loan repayments might be two or three thousand dollars a month.

If your breakeven point at the end of the month is zero, there's no cash left over to pay that loan back.

That shortfall won't necessarily show up straight away either. It creeps up two or three months later once you've collected your debtors and paid your suppliers, and suddenly your GST payment feels tight.

I saw this play out with a client this week who'd had two back-to-back months with basically no profit.

Their sales were steady, but they had non-business drawings coming out, a gym membership, life insurance, a couple of grand in drawings quietly whittling down the cash they'd built up.

Then in July they had a really strong month, expenses stayed roughly flat, and their bank balance filled back up.

Once they understood that cycle, they stopped panicking after one good month and started looking at their true breakeven over a quarter rather than month to month.

Ring-Fence Your Tax
Iif you're not ring-fencing money for the IRD in a separate account, your bank balance is a dangerous metric to judge yourself against.

Cash sitting in your main account after a profitable month might feel like "we're doing all right" but a chunk of that is the taxman's money. Skimming a bit off the top for GST and provisional tax as you go feels painful the first time you do it, but it becomes a habit fast, and it makes paying your tax bill a non-event rather than a shock.

The Number One Lever: Gross Profit Margin
If there's one lever business owners have the most control over, it's the gross profit line.

We see this constantly in hospitality direct costs like food, beverage, and wages go up, but owners are reluctant to increase menu prices because "times are tough."

So their margin slowly erodes: 45%, then 43%, then 40%, then 39%.

Every percentage point drop pushes your breakeven sales target higher you have to sell more just to stand still.

If it's been two years since your last price increase, that's probably the first place to look for relief.

Inflation Is Quietly Moving Your Breakeven Point
Inflation hits your breakeven point too.

If you're not watching your numbers as costs creep up, your breakeven quietly shifts from $50,000 a month to $55,000 or $60,000 a month over a year, and you won't even notice until it's biting.

How to Actually Work Out Your Own Number
If you're running Xero, here's the exercise:

• Run your profit and loss report: ideally over the last three years and look at your overheads line. Work out what a "normal" range looks like, stripping out anything abnormal.

• Find your gross profit percentage (there's a toggle in the Xero reports screen that shows percentages of sales): look at the trend over those three or four years to get your average.

• Drop both numbers into a breakeven spreadsheet (we've got a free one you can grab): It'll even let you work backwards from a target profit to figure out what sales number you need to hit.

• Break that annual number down into monthly and daily targets: units, hours, whatever makes sense for your business so you've got something to measure yourself against every day.

If you don't currently know your gross profit margin as a percentage, or your breakeven point, that's completely normal, everyone starts somewhere.

But this is one of those concepts that, once you grasp it, changes how you make every decision in your business.

It changes how you price a $60,000 piece of equipment finance decision. It changes how confident you feel when sales dip for a month. It changes whether you're guessing or actually know.

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This article is based on insights from the Next Advisory podcast, where Luke and Phil help New Zealand business owners navigate economic challenges and build better businesses. Visit nextadvisory.nz to find out how we can help you.

Checkout more of our blog content at https://nextadvisory.nz/podcast