As one year closes and another begins, there’s no better time to review the financial health and strategic vision of your business. This review should not be limited to only looking at past results—it should be forward-focused as well. Spending a little time planning for the future can help you anticipate challenges, take advantage of opportunities, improve your decision making and hopefully grow your business.
Perform a Break-Even Analysis
A break-even analysis is a calculation of the sales required to simply cover costs and can help you determine the minimum sales required to keep your business going.
The first step in the calculation will require you to review your expenses and categorize them into two buckets: fixed and variable expenses. This should be a relatively quick analysis and a helpful exercise that will also provide you with a reminder of where your cash was spent last year.
The next step is to compute your contribution margin percentage. Contribution margin percentage is determined by subtracting your variable costs from total sales and dividing the result by total sales.
Finally, dividing your fixed costs by the contribution margin percentage should provide the sales needed to break even.
Based on the results, you may determine your prices are too low and need to be adjusted. Before making any adjustments, you need to consider market conditions for your product or service so you can remain competitive. Assuming you’re already price-competitive, you may find your cost of goods is on the higher end of normal. Taking some time to strategize on ways to reduce cost without sacrificing quality will help profitability going forward.
Consider taking your basic break-even analysis one step further by running different models forecasting projected net income based on various sales levels. Visualizing what could be and setting goals based on actual results from the past can be a powerfully motivating technique to help increase focus of purpose and ultimately profitability.
Know Your Monthly Cash Requirements & Future Capital Needs
You’ve now finished reviewing last year’s cash outflows as part of the break-even calculation, but do you know what your outflows are on a monthly basis? Some businesses have consistent sales month after month; however, many businesses experience significant monthly sales fluctuations. These seasonal variabilities should be taken into account when planning for your business’s cash needs for the upcoming year.
Are there certain cash outflows that occur annually that will require significant cash reserves, i.e., year-end bonuses, distributions for taxes, etc.? What will the purchase of new equipment, the addition of a new product line or expansion of your salesforce do to monthly cash flow?
Putting together a monthly cash budget can help you determine good timing for large cash outlays and allow you to prepare for once-a-year expenditures.
Review Your Expenses in Multiple Ways
Most business owners spend time on a monthly, quarterly and/or annual basis looking over their profit and loss statements. During this review they tend to scan the expense accounts looking for outliers from budgeted amounts or examining some of their largest expenses.
Several other exercises can be useful to a business owner, such as sorting all expenses by vendor and by amount and performing a detailed review of any amounts recorded to generic or miscellaneous expense accounts.
Determine whether there are expenses being incurred that could be reduced or eliminated in the upcoming year. Research vendors that may be offering similar products at lower price points or with better payment terms. Recognize that a cost reduction should have a positive effect on your break-even and monthly cash budget analysis.
Review Sales for Opportunities & Concentration Risk
The analysis of your sales-by-customer report, sorted from highest to lowest, can be a valuable exercise. The sales-by-customer report helps you identify sales concentration risks your business may have. For example, you may find one customer is providing a significant portion of your company’s revenue. If this customer relationship is terminated, how would the loss of revenue impact your business’s ability to survive?
One way to mitigate a concentration risk is to diversify your customer base by adding new customers or by increasing your relationship with existing customers that might be underserved. It’s much easier to keep your existing customers happy than it is to cultivate a new relationship, so focus on increasing your revenue with existing customers first.
Review Your Transition or Succession Plan
Do you have a business plan for the next 5, 10 or 15 years? There are two very important dates in your life as a business owner—the day you started your business and the day you will exit. Perhaps you’ve already identified what options would be available if you wanted to retire. Allocate time to developing a plan, establish your time horizon for retirement and document what exit opportunities exist. Memorialize your thoughts in a living document and revisit your analysis at least annually. Talk with your business advisors and determine if there are steps you can take now that will make your vision a reality. You’ve put a lot of hard work and time into your business and should be rewarded for your efforts.
Every business is at a different stage within its life cycle, but no matter where your business is within this evolution, there’s value in performing an annual self-assessment. The above procedures should provide you with additional information that can be used to improve the financial health of your organization and assist you in making strategic decisions for the upcoming year.
Contact Nathan or your trusted BKD advisor if you have questions.