Break-Even Basics

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

  1. do we have enough space in the shop
  2. do we need an additional hoist/diagnostic equipment etc…
  3. 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.

How to maximize profit margins

How to maximize profit margins

PDC Auto profit margins

How to maximize profit margins

 

First things first, your service advisors must believe in the value they deliver to customers. When your team knows the importance of recommending appropriate repairs and services, then they feel good about their role in helping customers and are motivated to achieve goals that align with improving the bottom line.

How can shop owners and managers ensure their service writers are on board? Meet with them regularly and train them to understand your shops financial goals and the important role they play in meeting targets; better yet, create a compensation plan to reward them for achieving goals.

Also keep in mind

• Big ticket items will have a lower parts margin, but you’ll make more dollars per hour for the service

• While advisors have flexibility with respect to product pricing, ensure you have a product pricing matrix (see previous blog on this topic) in place as a guide; with your software rules settings turned on to automate the process

• Create incentives to discourage too much discounting, again bonus structures here can motivate service advisors to stick with your pricing matrix

• Focus on the sale of benefits of service v.s. listing parts and labour pricing to customers

• Minimize comebacks by selling customers the right service; this is a great team incentive to motivate technicians to diagnose correctly and rely on service advisors to book the next service

Ultimately, we can develop pay incentives and bonus structures to motivate service advisors and technicians to work together as a team toward a common goal, resulting in Increased Profit for the shop.

How to set and meet successful revenue and profit goals

I always recommend starting from the ground up. Working backwards to ensure we know the minimum gross profit required to cover the fixed expenses.

From this “floor” gross margin dollars amount, we can look at the net profit required to hit the company’s targets and how much more gross profit is required to meet this goal; whether it’s a plan to purchase new diagnostic equipment in the coming year or part of a longer strategy to increase share value for a sale of the business in 3 years’ time.

This information combined with best-in-class industry benchmarking, results in a “recipe” for average product margins, effective labour rate, and labour sales targets; carefully devised to produce a desired and realistic annual income statement result.

An important and often overlooked key to achieving success to hit your targets requires that Service Writers are provided with goals towards a specific mix of service types and parts sales.

Achieving the perfect combination of high margin service work blended with parts and labour sales delivers reliable gross margins to cover your fixed expenses and leave a healthy net profit to re-invest back into your shop.

Take the guess work out of goal development and build predictable forecasts that become your shops roadmap.

We work with clients across the country

If you want to work less in your business and focus on working on your business to make it more profitable, easier to run, and positioned for a sale, contact us and see how our team can change your life.

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PDC automotive accountants

Office Location

1593 Ellis St,
Kelowna, BC,
V1Y 2A7

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PHONE: 778-721-0536

FAX: 236-420-4184

EMAIL: milene@pdcauto.com