Great ideas are fun to imagine, design and develop. But in business, no idea is worthwhile if it can’t make money. How do you know if your idea could make money?
Honestly, you don’t. But don’t be discouraged! If you research carefully, you can get a pretty good sense of whether people would be willing to pay for your idea. My banker friends Jeff Arminger of BB&T and Steve Wientge of The Columbia Bank call this break-even analysis.
What is Break-Even Analysis?
A break-even analysis determines the amount of income your business requires to offset its expenses. It’s a pretty simple concept and there are plenty of resources that can help with the calculation. This is Business 101: You need take in more than you spend. Once you’ve done that, you can determine whether the amount above the break-even line (your profit) is significant enough to justify the resources you’ve poured into the business.
Now, you’re a sharp entrepreneur and an eager student of the business blog. You clearly know how important it is to create a break-even analysis rather than simply assuming your potential business can cover its expenses. Well, pat yourself on the back, because not everybody does.
It surprises my banking friends how many budding business owners show up at their door in hopes of a loan without a break-even analysis in hand. It’s one of the bank’s primary tools for screening out the entrepreneurs who are hopeful about their business from those who are serious about their business.
The break-even analysis is the great equalizer, the reason why a bank might fund a start-up out of a garage while turning away an established venture complete with all the bells and whistles. It doesn’t matter how big you are; if you can’t prove that you’re able to keep your head above that break-even line, you will sink.
How to Write a Break-Even Analysis
Several components factor into a break-even analysis. The basic ones are fixed costs, sales revenue, average gross profit for each sale, and average gross profit percentage. You will also be asked for a profit and loss forecast, a cash flow projection, and a start-up cost projection. These are the meat and potatoes of every break-even analysis and the cornerstone of any business plan.
I would go on here, but there are experts who (1) know more about break-even analytics and (2) can explain them prettier.
What If You Can’t Break Even?
If your break-even line is higher than you expected, you’ll need to take a hard look at your overheads. Do you need to be paying such a high rent? Is there a supplier who can charge you less? Can your business run on a skeleton crew or do you need all of your employees? Can you afford to raise your prices?
If you can’t cut back, you may need to scrap the idea. At least then you can take heart in the fact that you found out before investing your (or someone else’s) hard-earned money in a fancy new boat — with a hole in the bottom.
Beyond the Break-Even Line
If the forecast shows you’ll do more than just break even, then break out the champagne. But maybe not the stuff on the top shelf since you’ve still got some math homework to finish. A break-even forecast is only the first step. You’ll need a full business plan before you start investing any real money.
If you need help getting there, give us a call and we’ll point you in the right direction.
In the meantime, as always, good luck and good hunting.
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The Fisher Law Office is known for its experience in estate planning, probate administration, asset protection, and business development. Annapolis attorney Randall D. Fisher has practiced for over 20 years, maintains the highest peer review rating for ethics (AV Preeminent) by Martindale-Hubbell, and is a sucker for long walks on the fairways.