What is a Break Even analysis and how does a small business like A Touch of Tuscany benefit from this kind of analysis?
The financial analysis of any small business begins with a Break Even Analysis which tells the small business just how many units of products or service it has to sell to break even on its fixed costs. This is the most basic analysis that tells a small business owner like Jack Gordon how much they need to make to stay alive and stay in business. Need we say more.
At its very core the Break even Analysis takes into account all the fixed costs that a small business has to face; once this is done a determination is done to come up with a unit sales price for its products or services; the total fixed costs are then divided by that unit sales price to come up with the number of units of products or sales that have to sold by the business to break even on its fixed costs.
As you can imagine this is a critical analysis and how well a small business owner like Jack Gordon understands the fixed costs being faced by the small business, the better are the chances that the computation of the Break Even analysis will be accurate. Another way this analysis works well is that once the fixed costs are determined by the business owner, different values of unit sales prices are input into the Break Even analysis model to play what-if scenarios and come up with different break even points for different unit sales prices.
This way a small business owner can tactically raise or decrease the prices of the unit sales of product or service to arrive at the break even point and cover the costs of the business. For example, a business owner may determine that each month, the business needs to make $100 and therefore the business owner may choose to drop the unit sales price of the product or service to get to that $100 first, and then increase the unit sales price once the break even costs have been covered.
Some small business owners tend to take the other road and use a higher unit sales price for their goods or service to be able to get much as they can in the beginning of their monthly or quarterly goals and only later if they are still falling behind will they drop the unit sales price and offer discounts to meet their numbers.
Why can the Break Even analysis for similar businesses in the same industry of the same size be so different?
The reason for this of course is one of the key reasons the contribute to the success or failure of a small business - cost structure. Even very similar businesses operating in the same industry with the same size and client profile can have very different cost structures which of course entails that they will have different break even points. Thus even two franchisees for a major brand located in a target market like Westchester County, New York could have vastly different cost strcutures and therefore different break even points.
Break even costs for service oriented businesses - how are they different?
The key to remember that for service oriented businesses is that they don't really have any cost of goods sold - this item is factored into their operating expenses. This gives service oriented businesses a key competitive advantage and relatively lower cost structures and typically lower break even points. Thus a mortgage broker or realtor's office will not have a very high break even point since almost all the costs are of an operational and variable nature - although that does not always have to be the case.
Does having a lower break even point give a small business like A Touch of Tuscany an advantage over its competitors?
Yes - for the most part. If a small business like A Touch of Tuscany has a lower break even ponit it means that its has a better cost structure than its competitors and it needs fewer sales of its products or service to cover its costs than its competitors. This is of course very important since when slower economic times hit the industry, a small business like A Touch of Tuscany will be able to withstand the tougher sales environment much better than others who have higher cost structures and therefore higher break even points.
Just having a lower break even point does not always mean that you will be successful. For example if the competitor goes out and invests in a new technology that raises its operational cost structure but also gives it a great strategic advantage, it will actually benefit the competitor inspite of the higher initial break even point. However over the long term, there is no argument that the higher the cost structrue and break even point for any business, the more pressure it bring on the small business owners.
Understanding costs and controlling costs can be one of the most critical talents that a small business owner have to cultivate especially as the small business begins to grow. A balance needs to be struck between bold expansion costs and investments and frugality in the day to day operation costs.
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