The Break-Even Point In Your Service Industry

The Break-Even Point In Your Service Industry Is Not A Game

There is no better number to understand in your business than your break-even point.

I have seen businesses entirely focused on trying to achieve growth by having a razor beam edge fixated on their sales numbers only.

While it’s important not to lose sight of sales it’s not the critical number you should be only focused on.

It might surprise you that one of the most effective ways to drive profit is to focus on your break-even point.

Typically, the break-even point is used by manufacturers to work out how much revenue or units is required to sell to cover their variable and fixed costs. In my research in working out the best method, I was amazed to find that very little was dedicated to the service industry – my industry!

It opened a Pandora’s box for me. Did someone miss the memo? Have they not seen that Australia is saying goodbye to making things? The world economy is different now. Any left-over love for making things on the significant scale has moved over to China. The jobs of the future are in helping and doing, not in the making as harsh as that sounds.

Services are at the heart of our nation. It’s where we find the people who help:

  • Doctors
  • Lawyers
  • Teachers
  • Cleaners
  • Truck Drivers
  • Designers
  • Architects
  • Accountants
  • Engineers
  • IT
  • Drivers

While there will always be some form of small manufacturing in Australia, it’s safe to say we can easily base our whole economy on services. These services are exportable across the seas and have taken off in the last few years. Take for example financial and business services, because of the internet and online solutions, which can be one of our biggest exporters.

So, coming back to my initial point.

How does a service industry business work out their break even?

The complication in calculating a service business break-even is that the business doesn’t have a physical product to sell like a retailer or manufacturer.

The first step is to identify your unit. Example a consultancy-based firm bills their customers by the hour and an accounting firm charges by a tax return or suite of services, a training company sells courses, and other businesses might have a fixed price per customer, also known as value-based pricing.

In each case, they are all seeking to find out how many units (hours, tax returns, courses, customers and so on) they need to reach break-even.

Distinguishing your variable and fixed costs is where the complications are. The nature of a service-based business means that the most considerable portion of its expenses commonly relates to wages and salaries leading to difficulties in defining what is variable and what is a fixed cost.

We have picked out two different examples to highlight how this works.

Example 1

Business Type:  Consultancy
Unit of Measure:  Clients
Objective:  Find out how many clients they need to break-even
Total Fixed Costs:  $260,000 (Wages $182,000; Other $78,000)
Selling Price:  Average client will need 100 hours per year @ $125 per hour = $12,500 p.a.
Variable Cost:  Variable cost is $2,100 p.a. (includes printing, on-call consultants, room hire)

The Breakeven Formula

Total Fixed Cost / (Selling Price – Variable Cost)
$260,000 / ($12,500 – $2,100) = 25 clients
The business needs 25 clients each year to break-even.

The businesses income statement would look like this:

Unit

Total

No of Clients

25

Income

$12,500

$312,500

Variable Costs

$2,100

$52,500

Gross Profit  

$260,000

Fixed Costs

$260,000

Net Income

 

$0

Quick Capacity Check

While we know we need 25 clients to break-even the question remains does the business have the capacity to handle 25 clients.

A quick calculation to work this out is:

25 clients x 100 hours each per year = 2,500 labour hour.

Based on a 38-hour week operating 48 weeks of the year, the two consultants can provide

(38 hours x 48 weeks x 2) = 3,648 hours

At break-even the business operates at 69% capacity (2,500/3,648)

This means that the business is more than adequate to take on more clients.

Example 2

Business Type:  Accounting
Unit of Measure:  Charegable Hours
Objective:  Find out how many hours they need to break-even
Total Fixed Costs:  $85,000
Selling Price:  $125 per hour
Variable Cost:  $57 per hour

The Break-even Formula

Total Fixed Cost / (Selling Price – Variable Cost)
$85,000 / ($125 – $57) = 1,250
The business needs 1,250 chargeable hours each year to break-even.

The businesses income statement would look like this:

Unit

Total

Hours

1,250

Income

$125

$156,250

Variable Costs

$57

$71,250

Gross Profit  

$85,000

Fixed Costs

$85,000

Net Income  

$0

Quick Capacity Check

Assuming the business can call on only one person to provide the service.

A quick calculation to work this out is:

Based on a 38-hour week operating 48 weeks of the year, the one consultant can provide

(38 hours x 48 weeks) = 1,824 hours

At break-even the business operates at 69% capacity (1,250/1,824)

This means that the business is more than adequate to take on more clients.

If you are in a service-based business, take the challenge and calculate your break-even point.  This number forms the basis for key pricing decisions, volume and capacity planning in running your business.

All That Counts have years of experience working with businesses and helping them to understand the importance of break-even and strong margins.  Talk to us today and find out how we can help your business gain that competitive advantage.  We would love to hear from you.

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