Finance for entrepreneurs and non-finance
Each entrepreneur when decides to initiate a start up business have to perform a breakeven analysis, more precisely to estimate the moment when the business will reach the breakeven point.
But what do we mean by breakeven point?
We will start with the simple equation: incomes –expenses = profit.
Obviously the entrepreneur’s main target is to maximize the profit but we will not focus on this objective right now but to another first step in achieving this objective respectively profit =0. Breakeven point is that moment in time when the company’s income succeeds to cover the expenses.
! Take care total expenses include fixed costs and variable costs.
The moment when the company turns from periods with loss to profit =0 is very important because:
- Up to this moment the entrepreneur needs to bring money from home or to attract external finance sources;
- The moment when the breakeven point will be reached depends also on the pricing policy strategy because this will directly influence the company’s income.
To exemplify this we could take the example of a catering company which sells fixed menus.
- Both income and expenses (variable +fixed) will be estimated.
- Let’s assume fixed costs are 8,000 Euro than the company will reach it’s breakeven point (profit =0) when it will succeed to sell 1,000 menus at a unit price of 20 Euro/menu resulting in 20,000 Euro income. This is because at a level of 1.000 menus the variable costs are 12.000 Euro.
Let’s assume that based on our analysis the period when the company will reach breakeven is after 1 year.
! It is not so important that this moment to be reached very quick (even if this will be ideal) we need to know that this moment is different based on industry (manufacturing, retail or services).
Once we estimated this the entrepreneur have to be prepared the first year with the necessary financial resources to ensure the continuity of the activity. What we don’t want is to come to a moment of insufficient cash to pay the liabilities due to lack of financial planning.