Break-Even Basics
Break-even means your net earnings are exactly zero, you haven’t earned a profit or a loss.
Knowing this figure, essentially knowing your fixed costs in your business just to keep the doors open and everyone employed, allows you to calculate your minimum gross profit required to operate.
This is useful information in the event of a pandemic or other unexpected economic crisis, so you can pin point when and how you might need to adjust your business to survive.
Using break-even as a benchmark to know what changes you’ll need to make to target a particular profit goal in the future is how shop owners can plan for success and develop more specific goals for service writers and the shop.
The first thing you need to know is your total fixed costs.
These are all the expenses that your business incurs whether or not you make any revenue.
Typically, this is everything below your gross profit and if you look at your accountants financial statements you’ll have a more accurate figure that includes your income tax expense; also if you pay yourself in dividends, then you’ll need to add this to the expenses.
Shop labour might not be included in your expenses, though it really should be since it is a fairly fixed expense; If your shop labour lives up in Cost Of Goods Sold, then add that figure to expenses as well.
So we have:
Expenses + Income Tax Expense + Dividends + Shop Labour = Total Fixed Expenses
So in order to keep the doors open and continue to operate you need to earn Gross Profit = Total Fixed Expenses (At Minimum!).
Now figuring out your gross profit based on how much sales you need is a matter of understanding your average gross profit margin % (points) on your sales.
This next part is crucial to understand and I sometimes see shop owners mix this up.
To calculate this take Gross Profit and Divide by Sales so:
| Sales | $1,000,000 |
| Cost of Goods Sold (COS) | $ 600,000 |
| Gross Profit (sales – COS) | $ 400,000 |
| Gross Profit | $ 400,000 |
| Divide by Sales | $1,000,000 |
| Gross Profit % (Points) | 40% |
So with average gross profit % of 40% (that’s the average points on sales) then to achieve the minimum break-even of let’s say $500,000 then the shop calculates sales required as Break-even/(1/40%). So 1/40% = 2.5.
This 2.5 is your multiplier that you must multiply by your break-even :
| Break-even | $ 500,000 |
| X’s (1/40%) or 2.5 | 2.5 |
| Sales required = | $1,250,000 |
Knowing this figure and breaking it down further by quarter (need to ensure you have a large portion allocated to the Oct – Dec quarter and March – May) then you can really start to monitor how your business is performing.
If this is the minimum required to cover your costs, then you know any additional sales result in bottom line additional revenue.
So if your break-even is met then for every additional $1 sale you add $0.40 to your bottom line.
So if you want to earn $100,000 in net profit then you actually need to increase sales by $100,000 x’s (1/GP%) =$250,000
| Additional net profit | $ 100,000 |
| X’s (1/40%) or 2.5 | 2.5 |
| Sales required = | $ 250,000 |
It’s easier said than done to increase sales by $250,000, and you have to consider other factors such as
- do we have enough space in the shop
- do we need an additional hoist/diagnostic equipment etc…
- do I need to hire another technician
There’s another important fact we aren’t looking at here and that’s the average profit margin % the shop currently earns.
See 40% as an average is very low and is not in line with industry averages.
The top performing tire shops we work with, earn an average of 60% gross profit margin% (remember labour is NOT in cost of goods sold, if you have labour in cost of goods sold then 40% is actually good, you just need to back out labour and see what you’re really at if you want to follow these recommendations).
So if the shop now focuses on improving average gross margin % even just by 2 points, keeping the cost constant at $400,000 (because we’re doing the same business as before, just with a better profit margin % or points).
Figure out our sales as our $Cost of goods sold/ (1-42% points target) = $600,000/58% = $1,034,483
| Sales | $1,034,483 |
| Cost of Goods Sold (COS) | $ 600,000 |
| Gross Profit (sales – COS) | $ 434,483 |
| Gross Profit | 42% |
For every increase in average profit margin % (points) you are adding cash directly to your bottom line.
Now lets look at a top performing shops 60% gross profit margin and how that affects the bottom line
Figure out our sales as our $Cost of goods sold/ (1-42% points target) = $600,000/40% = $1,500,000.
| Sales | $1,500,000 |
| Cost of Goods Sold (COS) | $ 600,000 |
| Gross Profit (sales – COS) | $ 900,000 |
| Gross Profit | 60% |
When I say top performing shops operate more smoothly, with less time working in the shop by owners and less stress for the team, it is this approach to focusing on strengthening the profit margins first that achieves these results.
Because tire shops sell 2 things 1 – Products and 2 – Labour we have to analyze what margins are now and strategize on how to make incremental improvements to improve the shops performance.
With our concentrated efforts working with owners and management to develop an appropriate Product Price Matrix and Service Code matrix; making use of the available settings in shop management software we can dramatically improve the profit margins.
