Awards & Engraving

March '20

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But let's say you dismiss the notion of polling your clientele and go with your gut instincts. You should still play a little "what if?" in making any decision. In an ideal world, a company's decision to change its physical location, hire more people, add new products to its mix, or buy new machinery should be an integral part of its business strategy. The rule of thumb about when to make a move is that you should only expand when there are growth opportunities that can benefit your business and give you an immediate — typically, less than one year — return on investment. Think of it as planting a tree that already bears low- hanging fruit. There may be an untapped market niche on which you want to capitalize; or, perhaps, a new location that will deliver significantly greater traffic at your grand opening. In any case, whatever change you initiate, have a well-developed plan with plenty of contingencies should events not pan out as expected. THE BEAUTY OF BREAKING EVEN You must appreciate that expanding oper- ations does not always guarantee success. The only point being made here is there are no guarantees, but a lackluster result is certain if you don't know how much more you need to sell in order to cover your investment. Allow me to introduce the Break-Even Formula: Fixed expenses (overhead) Break-even volume=Gross-margin per- centage – Variable-expense percentage If you refer to the company's most recent Consolidated Income Statement (aka, profit-and-loss [P&L] statement), you should be able to locate or calculate your gross margin percentage. It's usually near the top of the statement on the line labeled Gross Profit. If, on your P&L statement, there isn't a separate column with the heading Percent of Sales, you may have to take that dollar amount and divide it by the top line, Total Income or Gross Sales Revenue. For example, if the company's gross sales revenues are $1,200,000 and the Cost of Goods Sold is $500,000, then the Gross Profit is $650,000 and the Gross Margin Percentage is 54.2% or 0.542 ($650,000 / $1,200,000). Next, look down the rest of the P&L state- ment, and classify each line item as either Fixed Expenses or Variable Expenses. The eas- iest way to do this is to go line-by-line and ask yourself, "Would the company be required to pay for this regardless of how much product or services it sold?" If the answer is yes, then that total gets added to the Fixed Expenses. If the answer is no, that amount is determined to be a Variable Expense. For instance, if the company does not have an advertising firm on retainer or on a fixed contract, and it decides to promote and market itself as the need arises, then the total spent on advertising would be classified as variable expense. Conversely, the line item labeled Payroll Expenses — compensation and taxes for salaried employees — usually becomes part of the Fixed Expenses tally. Commissions and bonuses paid to sales- people, being determined by how much was sold, is considered a variable expense. Once you have a total for Variable Expenses, divide that amount by the Total Income or Gross Sales Revenue to come up with the Variable Expense Percentage. Let's say the variable expense total, for the same example above, is $240,000. The Variable Expense Percentage would be 20% or 0.20 ($240,000 / $1,200,000). Finally, if the Fixed Expenses totaled $400,000, the Break-Even Volume would be $1,199,262 ($400,000 / 0.542-0.20 or 0.342). It is at this point that a smart business owner can play "what if," provided only one factor is changed at a time. WHAT IF? Let's suppose the above example describes a successful awards shop that has decided to buy and finance two new laser engravers that will add $60,000 to its annual fixed costs. In this case, using the Break-Even Formula will definitely help. W h e n Fi xe d E x p e n s e s c l i m b t o $460,000, the new Break-Even Volume becomes $1,345,029 ($650,000 / 0.342) — an increase of $145,767 or 12.2%. The next most logical question is: "Can the business sell 12.2% more stuff to cover the investment in the laser and other tech- nology?" Here's where information from the VoC or other market research comes in handy. The beauty of the Break-Even Formula is how clearly it indicates the effect of any change to the organization — hiring a new salaried employee, raising or lowering Break-even volume Fixed expenses (overhead) Gross-margin percentage Variable- expense percentage – = 22 • A&E MARCH 2020

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