Do You Know Your Cash Flow Break Even Point?

INTRODUCTION:

We've all heard of a break even point for profitability. But I firmly believe a break even point based on cash flow is just as, if not even more important!

So how do we go about working this out?

Figure 1: Working out what round you need to shoot to win is no different in business with cash flow

1. understand how long it takes to get paid

It's always a good idea to work out how long it takes you to get paid. Make sure you get your year end accounts and look at your debtors and total sales. Looking at crucial cash flow calculations is paramount.

2. Establish how quickly you turn your stock over

If you sell stock, you need to understand how long you are taking to sell your inventory units. Cash flow is often tied up in slow moving stock.

3. how fast are you paying your suppliers?

Do you pay your suppliers within terms or outside of terms? It's important to negotiate longer trading terms if possible but do not pay outside of these as although they could assist your cash flow initially, if your creditors delay supply due to non-payment it could affect sales and overall profitability.

4. what are Your loan repayments?

This is where it is possible to still go broke with making a profit and vice-versa. Loan repayments in conjunction with poor debtor days, low supplier days and high inventory turnover days can be disastrous! Work out what your principal and interest repayments are for the year. Debt repayment terms can be a cash killer particularly when the business is just starting!

5. what are your drawings/dividends?

How much do you need to take over your salary each year? Don't forget to include tax on any dividend and other income besides your after tax wage/salary.

6. WHAT ARE YOUR fixed overheads?

You need to know what your fixed overheads are going to be for the year - like the others above and below it is crucial to understanding your break even point regardless of cash flow or profitability.

Figure 2: The days of just being a compliance accountant are over! Accountants need to assist their clients in a business advisory capacity and in a proactive way.

7. WHAT ARE YOUR gross profit margins?

What is your average margin on sales in percentage terms? Again speak to your accountant or business advisor or get them from your accounting software such as Xero or MYOB. Ring your accountant to go through these with you. If you have a cloud accounting system, they should be able to log in and go through the numbers with you.

8. perform a cash flow forecast

Once you have the above information, consider 3 way budgets and work out whether you are going to be cash flow positive for the year or cash flow negative. If it's negative you need to change something with your business planning. perform some differing cash flow forecasts to work out what scenarios you could have or like to see.

7. calculate cash flow break even sales

Now, if you worked out for example that in terms of cash flow forecasts you will physically be paying $100,000 in loans, $50,000 in dividends and $150,000 in fixed overheads, if your gross profit margin is 30%, then you would work out you need $1,000,000 in sales. HOWEVER, because you know that it takes you 45 days to get paid and your inventory takes 30 days to turn over and your supplier days are 30 days, you work out that you actually need to make approximately $1,100,000 in sales excluding GST to make a break even cash flow point.

You can then either choose to fix parts of the above 'recipe' to reduce this figure and/or increase sales, improve margins, reduce overheads etc. The options are endless if you just take the time to explore what could be possible to fix the problem and even better than that generate more profit, more cash flow and a higher business valuation for your business!

CONCLUSION:

Yes the above might all seem a little complicated but it's vital you consider the possibilities for your business. If you don't have a handle on these numbers seek help from your accountant who should be assisting you with these things. Profit is important but cash in the bank is imperative!