The Break-Even Point in Retail
An analysis of sales and expenses
The break-even point in your retail business is when sales are equal to expenses. At the break-even point, there is no profit and no loss. It is a very simple view of the retail business. The theory being that if you can get to break even, you can "cash flow" the business.
Remember, the P&L statement tells you what happened at a given point in time, but it cannot tell you how long you can sustain your business. For that, you need a cash flow analysis.
This formula is also referred to as Break-even Analysis. At the heart of the break-even point is the relationship between sales (revenues) and expenses (fixed).
Break-Even Point = Fixed Costs / Gross Margin Percentage
Example: Your retail store buys golf clubs for $15 each, marks them up and sells them for $30. Your monthly expenses (fixed costs) are $10,000.
This means your breakeven point would be $20,000 or 667 units.
Let's see how that works:
For $, it would be, $10,000 ÷ (15/30) = $20,000 -or- $10,000 + 50% = $20,000
For units it would be, $20,000 ÷ $30 = 667 units
You might think that the formula is: (sales - expense).
That makes the most sense. But looking at the margin is a predictor. And that is what you need. Looking at sales minus expenses is telling you what happened, not what will happen which is what is important here.
For example, if your store had the street closed for repairs out front and no one could get in, then your break-even point is more impacted by sales than expenses. Meaning that if your margins during this time were still at budget or plan, then the "fix" is getting more customers.
So when the street is repaired, the people return and you will be fine. On the other hand, if your sales are fine, but your margins are not at the expected levels, more customers will not help you break even. You have to fix the margins, first.
Making a Plan to Improve Margins
Another consideration is when planning your margins in the beginning. Many retailers forget that many of the products they buy will have to be discounted below the Initial MarkUp (IMU) in order to be sold. This means if you use the gross margin of the units based on IMU, then you will get a faulty calculation since many will be sold for much less.
This formula is simple to follow and understand. However, what is important is the trend to get to break-even. If you are at break-even on the trend upward, then it is a sign of health. But if you are at the break-even point on the downward trend, then it is a sign of impending disaster.
One of the critical mistakes small business owners make is trying to "cut" their expenses to get to the break-even point. While this will work for a period of time, it is managing the downward trend of your business and you will soon find out you cannot cut your way to profitability – eventually, you will have cut too deep and cannot sustain any growth or trend back toward positive growth. It takes cash flow to grow the business and if you cut too deep, you will lose that cash.
The term "Black Friday" was coined many years ago in retail to mark the break-even point for the year of a retailer. Since so much of the revenue comes in the last 5 weeks of the year due to holiday spending, most retailers are at a loss for the year until this day (the day after Thanksgiving).
Today, everyone knows about Black Friday as retailers are now using the term openly in advertising. While the average customer can tell you when Black Friday is, they cannot tell you what it means – to them, it's just another sale.
When writing a business plan, you will need to plot the break-even point for your retail business. For many retailers (if not most) it is not until year three that we see real upward trends. The first few years have so many costs associated with customer acquisition that it is hard to reach break-even.
A Business Owner's Salary and the Break-even Point
Here is the hardest reality for the retail business owner. If you are the owner of the store, the break-even point is where you must be before you take a salary. Take it before that time and you are simply draining your cash. Also consider, if you are taking a salary from the beginning, then your financial plan should show a break-even point much further down the calendar since salary, in this case, is a fixed cost.
A number of retailers end up failing because of this last point. They fail to plan for their own payroll (or lack thereof) for the first year or two. While you can pay yourself a salary during this time, you should only do so if you are the employee as well. In other words, would the business have to pay someone to fill that role?
An example of this would be if you were the owner and the store manager. The business requires a store manager to operate. If you serve that role, then you can pay yourself that money.
Many people dream of owning their own business but don't want to put the hours in for actually operating it. They see it as an investment. With today's expenses (payroll, insurance, rent) it's just not possible.