Setting minimum sales target is always a challenge for Small Businesses, especially in the first few years of business. As startups, you might have set “handsome” targets to show your future investors, but for the purpose of business management, let’s just look at the realistic picture and plan from there.
Before going into your “big plan”, take a step back and ask yourself this question, “how much sales do you need?”. You have your commitment to meet, be it in business or personal. The sales you made minus all the business expenditure must at least be positive (or minimum at zero) so you won’t struggle. In financial term, we called this “break-even sales“.
And in this exercise, I would like you to look at the Break-even Sales in a non-conventional way. Let me explain the difference.
- Break-even Sales (accounting) – This means the minimum sales you need to achieve so that your company’s Profit & Loss Accounts (“P&L”) are not in the red. You simply calculate this by using the following formula:
[Company’s fixed expenses (value) / product’s gross profit margin (%) ]
For example, your company’s fixed expenses are rental, salaries, utilities etc, all in about RM120,000 per year, and your average product gross profit margin is 20%. That means that your break-even sales for your company is RM600,000 per year. By setting your sales target below RM600,000 , you are putting your company in trouble. As simple as that.
- Break-even Sales (cash flow) – This means the minimum sales you need to achieve so that your company’s P&L are not in red, at the same time taking into consideration your commitment which are not in your P&L, examples are loan repayment, hire purchase, tax installments etc. The formula is as follows:
[Company’s fixed expenses + cash commitment which are not in P&L (value)] / product’s gross profit margin (%)
Continue from the above example, your company’s fixed expenses in P&L is RM120,000 per year, and cash commitment not in P&L totalling RM50,000, this means that your break-even sales is now (RM170,000/20%). I.e. RM850,000 per year. Please take note that this is the minimum sales you need to achieve per year by taking into the consideration of your cash commitment which are not in P&L. This doesn’t mean that by achieving the break-even sales under this category, you will have no cash flow problem. Bare in mind that you still have to manage your receivables and payables.
- Break-even Sales (personal) – many startups and young entrepreneurs are focusing in making sure that the company is profitable, by not taking salary nor charging petty expenses into the book. I’m not promoting the charging of your high salary nor personal expenses into company. However, for the break-even sales exercise, I suggest you include your personal commitment (such as housing loan, car loan etc) into the equation.
[Company’s fixed expenses + cash commitment which are not in P&L + personal commitment (value)] / product’s gross profit margin (%)
With the example from above, your company’s fixed expenses in P&L is RM120,000 per year, and cash commitment that are not in P&L, totalling RM50,000 , plus your personal commitment of RM30,000 per year, and your break-even sales now stands at RM1,000,000 per annum.
Imagine if you are using the conventional way of setting a minimum target for sales, and you will be happy to hit anything above RM600,000 as the company’s book will show profit. Nevertheless, you will still struggle with cash flow issues since other cash commitments are not been considered.
This calculation will ensure you set a minimum sales target to achieve company’s profitability, and cater for expenses which are not in the P&L accounts and surpluses to handle your personal commitment.
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Article can be found in Entrepreneurs Insight magazine, March 2018