This article is the second of a series sharing some key learning from our upcoming ICFE session, “Profitable Growth through Multi-Unit Expansion“. Click here to get the prior article.
Today’s article features Chapter 2, Profit is Not Optional. It helps franchise executives and franchisees expand their thinking about an old friend, breakeven analysis, transforming it from a dry calculation to a powerful tool for profit planning.
Breakeven is a formula – not a goal! Well, if you’re losing money, it’s a goal. But the real power comes from its many uses planning for profit. Because Profit is Not Optional. That’s why we always reframe the breakeven equation for what we call, Breakeven Plus. A profit growth mindset begins with knowing the sales required to reach your goal.
Understanding Your Cost Structure is the Foundation for Profitable Decision-Making
You can’t use the formula until you have your numbers. Start by reviewing your current costs and identifying which are fixed and which are variable. Variable costs rise and fall in alignment with sales. But at what rate? You’ll need to know the percentage of sales that your variable costs consume, and what is left from each sales dollar after variable costs are paid. The amount remaining is called the “Contribution Margin”. The contribution margin is the portion of each sales dollar available for fixed costs and profit. The variable cost percentage, contribution margin percentage and fixed costs (in dollars) represents your cost structure. Understanding this cost structure is a foundation for profitable decision-making.
Breakeven and Breakeven PLUS
Once you’ve established your cost structure, you have the information you need to calculate your Breakeven, and more importantly, your Breakeven PLUS.
Here is the recipe for Breakeven:
Fixed Costs divided by Contribution Margin %
This formula calculates the sales needed to cover all the fixed costs. But no more.
The profit growth mindset begins with planning for a profit. So we make one simple adjustment to the recipe to find the sales needed to cover the fixed costs and more – enough more to yield your target profit.
Here is the recipe for Breakeven PLUS:
(Fixed Costs + Profit Goal) divided by Contribution Margin %
The Magic Number Short Cut
What sales are required to cover a marketing investment or the costs of a new sales team member? There is a short cut to finding out. It is as simple as multiplying the cost of the opportunity you’re considering by your magic number. Chapter 2 defines how the magic number is determined. This multiplier is hands down the most useful information you can have when growing a business.
Here is the recipe for your Magic Number:
$1 divided by Contribution Margin %
Moving from Short-Term to Long-Term Profit Planning
Businesses require both short and long-term profit plans. In the short-term, combine your intuitive understanding of the business’ cost structure with a little practice using the formulas. From this you will gain the confidence and skills to make a compelling business case for adding staff, budgeting marketing investments, investing in equipment and setting prices. These are all important decisions to make in the short-term.
In addition, a new business must know what it takes to break even – and how long it will take. Because until you do, you’re burning cash.
Some believe a business that breaks even is sustainable – but it is not! Every business MUST make enough profit to do three things. Reinvest in the business to grow tomorrow’s profit and value, pay back existing debt and pay a reasonable return on investment to the owners.
For the long-term viability of the business, seasoned business people shift from thinking about what it takes to earn a profit to planning how profit will be used to grow the value of the business. Profit is an important source of capital for a small-to-medium sized enterprise. How much of it is already earmarked for debt repayment? What assets will you need more of, and will there be enough profit enough to grow them? If not, how much debt should you take on? How much will be paid out to owners – and when? With a profit growth mindset you ask and answer these questions strategically. Be intentional about how you use profit and create your own pathway to growth.
Reinvesting profits from one location to acquire another franchise location is a natural growth pathway for many franchisees. Distributing too much of the profit, too soon, compromises this opportunity. To ensure successful expansion, franchise owners must be intentional about HOW profit is used.
How Can Franchisors Help?
Franchise professionals who attend our workshop (see below) will identify strategies to help franchisees reach their Breakeven Plus as quickly as possible, and to become intentional about how profit is used. To identify whether your franchise system is doing all it can to support a profit growth mindset, take the Chapter 2 Self-Assessment.
If your score is less than 100%, this workshop is for you!
Driving Profitable Growth Through Multi-Unit Expansion | Saturday, February 26, 2022
This pre-IFA conference workshop is hosted by the Institute of Certified Franchise Executives (ICFE). Attendees earn 200 CFE Education Credits. Learn more about the session, including registration details here.