Working out break even

[shazoom]

Hi everyone, this is my first post here.
I feel a bit silly asking this question because I'm showing my ignorance. I've been running an electrical contracting business now for almost 11 years. I'm very good at my job, but to be honest, I have no idea how to run a successful business. I've been winging it for too long now and only just covering my costs, I feel in the down turn, it's high time I got educated.

A few years ago I changed my accountant and he talked me into going limited, which I did. However I know less about being limited than I did about being a sole trader. I've been trying to calculate my break even point and I'm a bit stuck on something, I wondered if anyone could help me out please.

I know to work out break even per billable hour I have to calculate my total overheads and divide it by the hours I'll be working in a year. I assume my wage will be one of those costs, so lets for arguments sake say I want to be drawing £26'000 a year to pay for my food, mortgage etc. Do I just allow this figure in my calculations or do I have to allow for taxes too? What I mean is if I'm to be taxed say 20% of £26'000 I'll only actually get £20'800, but I need £26'000. To counter this I could put 25% onto the £26'000 and put this new figure into my break even point calculations. Would this be correct? I need to get this right or I could price myself out of work.

Any help here would be greatly appreciated and sorry in advance for this stooooooooopid question :|

PS
Not sure if this is in the right section, please move it if it is.

 

[DickM]

Sorry, but I think you are totally on the wrong tack with your pricing strategy.

If your product or service is not unique, then you should gather pricing data from your competitors, and attempt to "commonise" the data with your prices - so that you are comparing apples with apples.
Only by carrying out this exercise, will you ensure you have a sustainable business by pitching your prices within (say) a 5% +/- difference of the competition average.
With regard to your break even position - I suggest you contact an accountant (if you don't have one already), to calculate this for you.

p.s. IMHO you would have got a better response if you had posted your thread to the main "Accounts & Finance" Business Forum.

Good luck

 

[shazoom]

Thank you for replying DickM and thank you for pointing out it's in the wrong place. I wonder if a moderator would be kind enough to move it to the appropriate place?

Okay, as to your suggestions, well I've been doing what you've advised for the past 11 years, however I feel that the electrical trade is full of people that have very little experience and are working for a much lower rate than is deserved by the rest of us, however that is a discussion for another forum and rages on.
I have an accountant and he appears to be doing his job, but therein lies the problem, I don't know if he is or not. I have asked him to calculate my break even but he always avoids doing so claiming I don't need to know such things. I personally don't think there is anything wrong with wanting to understand more about my business. I'm looking at a new pricing system that is currently doing the rounds in America and seems to be doing very well there, however I need to understand more about my business to see if it is viable or not.
It is my understanding that all successful business people know every nut and bolt of their business, I'm merely trying to know mine.

 

[Gary Hornby]

Hi,

I have an accountant and he appears to be doing his job, but therein lies the problem, I don't know if he is or not. I have asked him to calculate my break even but he always avoids doing so claiming I don't need to know such things.

If this really is the case I suggest you find another accountant. His/her job should be to help you understand YOUR business.

Calculating a break even point is usually pretty straightforward, but it is only the starting point for your pricing strategy. As the previous respondent says you need to take account of your competitors pricing and also attempt to identify and exploit a unique selling point (such as the way you deliver your services or a specific target market) if you can. This might enable your services to be less price sensitive although I do appreciate the highly competitive nature of electrical contracting.

Best regards,
Gary

 

[crphillips]

Pricing is tricky.....you really need to see what your competitors are charging..........if your better than them and you want to charge more then you can do that providing your sales patter is good enough. We charge more than our competitors but we turnout a far superior job. Getting this across to the customer is the hardest part though so it depends what your confidence and sales pitch is like as to whether you can get away with charging more than your competition.

I think working out your break even to include wages and then figuring your hourly rate on that you may be under selling your self or vice versa......at the end of the day if there ain't enough money in it you may be best looking at another line of work.

I have a mate who is a sparky......he was really struggling on domestic stuff as he's vat registered and the guys he was up against weren't........fortunately he's very good at what he does and has gradually managed to move into the commercial sector......vat isn't an issue now and he's so good at what he does that companies are bashing his door down for him to be their sparky.

 

[oldeagleeye]

First of all. I have to question what an earth your accountant is up to in advising you to go LTD and then not explaining the pros & cons and one of the biggest pros is that on £26,000 would wouldn't pay a penny in tax and NI.

You can in fact claim £6475 a year directors salary and just over £37,000 a year in dividends. A total of around £44,000 tax free and NI free.

Sounds great does'nt it. Unlike when your self-employed however you pay Small Companies Corporation Tax. After deduction of all your everyday operating expenses this is charged at 20% for small companies with a net pre tax profit of £300,000 a year.

Now I don't know how much you turnover or what your expenses are so I am going to take a wild guess and assume you are working a 40 hr week @ £20 quid an hour and that you make another £200 a week on materials bought at trade prices.That is £1,000 gross.

We then have your expenses which we will keep to a minimum. You have your own car or van for which you can charge your company 40p per mile. 200 miles a week is

£80 Fuel
£10 Phone
£25 Leaflets
£15 Accountant

Total £130 a week x 50 = £6500. On top of that you can add your directors salary and the same amount for your wife if she is not working and helps with the paperwork. That is another £12,500. Total Operating costs £19,000. Deduct that from 50 x £1,000 = £50K and your net pre-CT tax profit is £31,500. SCT @ 20% £6300 leaving you some £25,200 to pay in tax free dividends.

Lets not forget however. You have already had £12,500 between you so under this example you have taken home just under £800 a week tax free

Now quite frankly if I were a qualified electrician £800 a week would seem to be a reasonable wagefor a professional trademan. While your break even point may be lower then I would demand at least £25 per hour -min 2hrs.

Rob

Yes guys I know I have not mentioned the 10% TC didn't want to confuse the OP in a rough illustration.

 

[internetspaceships]

OK, to answer the OP's question.

Take all your annual bills and add them up.
Estimate your electricty, phone, fuel, marketing etc too and add them as an annual cost.

Throw in your salaries, wages, bank, finance, accountancy fees and anything else you can think of(I think you get the picture here mate)

Divide it all by 12 and you get a very approximate monthly cost - i.e. break even point.

I'm sure some people could come on and try to over complicate it but in a nutshell, it's a way to work out how much margin you need to make in a given period to cover your overheads.

If you need to make £10,000 per month then assume there are 22 working days per month (as an average) and you'll need to make a gross profit per day of £454+ VAT to break even.

Add you own numbers in to this, a spreadsheet is a cracking way to do it.

 

[bizloanservices]

To answer your original question on how to calculate your break-even point, here's the technical answer.

To work out the break-even point, you have to understand the concept of fixed and variable costs.

Fixed Costs

Fixed costs are overheads that have to be met regardless of whether sales are made or not. Fixed costs are expenses which do not vary when sales go up or down; you will have to pay them regardless of what level your sales are at.

If you were running a shop, for example, your fixed costs would include:

• Rent and rates
• Electricity - you have to keep the lights on to attract customers into the shop
• Wages for one member of staff, or even for yourself
• Insurance
• Depreciation (although this is a non-cash item, it is regarded as a fixed cost)

Variable Costs

Variable costs are expenses that fluctuate according to the level of trading. As sales increase so will your variable costs. Conversely, when sales fall these expenses will also fall.

Examples of variable costs would be:

• Raw materials and stock - as sales increase you have to buy in more materials or stock in order to meet the increased demand. This is the most common variable cost.
• Casual labour - most salaries are considered as fixed costs but if you employ casual labour to meet rush orders then this is a variable cost.
• Stationery, telephone etc. As we will see later, some of these are semi-fixed but taken as variable costs.

Break-even is achieved when a business has generated enough gross profit to meet its fixed costs and variable costs. Unless they generate sufficient sales or curb costs then the business will be loss-making.

Break-even is worked out as follows:

Fixed Costs / Contribution* x Sales

*Contribution = Sales less Variable Costs (contribution is effectively what is left over, after variable costs have been met, to meet fixed costs)

The figure you have is the level of sales you need to achieve break even.

To calculate your break-even point first go through your Financial Statements or projections and categorise your costs into fixed and variable costs.

Consider each cost and ask yourself these two questions:

Question 1: "Even if I only had one customer, would I still have to pay this cost?"

If yes, then it is a fixed cost

Question 2: "Will this cost increase if my sales increase?"

If yes, then it is a variable cost.

There are some costs which can have an element of being both fixed and variable, for example, electricity; an element of the bill is fixed but at the same time usage may go up as sales increase - this depends on your line of business. It's just a case of taking a view when you're splitting everything out.

However, if you are comparing your break-even year-by-year on a basis of trends the trick is to be consistent in your definition of fixed and variable otherwise you won't be comparing like-with-like. So if you decide that because you are a manufacturer your electricity costs will be variable, then in future years’ calculations keep it this way.

Having done this exercise you can then work out your break-even sales figure and identify what your margin of error is in terms of sales before you start making losses i.e. how far your sales can drop before you're into loss-making territory, or if you want to think positively, at what level of sales do you start making a profit.

Hope that makes sense.

 

[Fürgefutár.hu]

Price yourself higher than the competion... sell on value of service not price. You should not be the cheapest in the market