Understanding Break-Even Points and Why Every Revenue Generating and Earnings Protecting Employee Should Understand Them
by Bill Albert, President
BMI Global Consulting
The last two years have been very difficult for a multitude of companies in a multitude of industries.
Companies have been impacted with a myriad of added expenses that had not been considered when putting together their short and long-term forecasts. Some of those cost went unnoticed by many. For example, when covid hit and millions of employees were forced to work from home, companies were paying salaries to a workforce that was not returning the value of the salary. All of a sudden parents or singles, who were normally in the office, were taking care of children or other family members, handling pets, scuttling errands and a whole host of things which they would not have been doing had they been at work. There is a direct link between paying an underutilized workforce and profitable earnings numbers. However, because they are tied to salaries it is often overlooked and goes unnoticed.
Some industries were devastated and were forced to let large portions of their workforce go. The notion that turnover is just a ‘cost of doing business’ could not be more wrong. Turnover and the subsequent onboarding of new employees affect not only the Overhead Statement they also have a direct impact on a company’s earnings. It’s no wonder that many organizations today are trying to find every means possible to protect their net income and look for creative ways to drive profits.
In August of 2020, my business partner and I were having a conversation with the CFO of $285M electrical distributor. The sales dollars were going up every year, but the earnings percentages were actually decreasing. We were looking at some of their financial indicators, break-even points, cash flow cycles, etc.
During our conversation, she made an off-hand comment that she wished her revenue-generating and earnings-protecting employees understood break-even points, because if they did, it could potentially revolutionize the way they look at the business and change their selling behaviors.
That one single off-hand comment has changed the financial trajectory of multiple companies since August of 2020.
Over the years, we have been blessed to work with numerous organizations around the world. Their values ranging from millions of dollars to billions. Our take-away from these experiences is that the vast majority of the professionals working for these companies understand what their jobs are and how to do them. What we have also discovered is that many of these same employees don’t actually understand the ‘Why’. Looking at break-even points begins to answer some of these questions. And this concept has become a central focus for us since then.
Introduction to break-even points.
The purpose of this article is to give a basic introduction to the concept of break-even and demonstrate why this financial concept should be taught to your key revenue-producing and earnings-protecting professionals. So, what are break-even points, and why are they so important for our sales and operations personnel to know. Let’s explore.
First of all, what is a break-even point?
In its simplest definition, a company’s financial break-even point occurs when its sales revenues and their expenses reach a point during a fiscal calendar year when they are equal.
In other words, when my sales revenue and my costs of doing business are the same, break-even occurs. A company does not begin making a profit until it has surpassed the amount in revenue needed to cover the costs it takes to run its business.
OPERATING EXPENSES + COGS = REVENUES
Let’s look at a $200,000,000 distributor that wants to make 20% on the Gross Margin (GM%).
Graphically we can view it this way below:
So, what happens if our sales force decides to give 1% away on price.
What does that look like, and why is that such a big deal?
Break-even points give us the financial ‘why’ behind this potentially terrible decision and why leaders are justified in constantly driving a margin conversation. Let’s look at this deeper. First of all, we know it’s not just 1% that is normally discounted. For our purposes, however, this is what we will use. When we give 1% away, several obvious things happen:
- First, notice that the company value is no longer $200M. It’s now $198M.
- Second, notice that the GM is no longer $40M. It’s now $38M.
- Lastly, notice that we actually lost $2M in Net Income. That’s a $2M loss of Net Income Dollars.
But that’s just the beginning. (It doesn’t matter if you master the following formula. It’s the story I want you to follow.)
When we follow the formula on the bottom left, we find that in order to break-even, we have to sell $212,164,074!
Let that sink in.
In order to break-even on the 1% your sales force gave away in price, you have to sell an additional $14,164,074 just to get back to par. (In this example.) You see this in the top right corner of the graphic by the arrow.
The damage does not stop there. I’m not aware of a single distributor that has not been negatively impacted by supply-chain difficulties. Many of them are spending millions more on products than they normally would and housing them in their warehouses to make sure they have the products needed to provide an excellent customer experience.
When we take a deeper dive into the above story, in order to satisfy the additional sales needed to achieve break-even, the distributorship would need to spend an additional $11,428,572 just to support the $14M plus you need to achieve par.
In this example of 1%, the right arrow below reveals there is now an additional COGS that is $11,428,572 higher than the original $160M on the arrow to the far left.
Included in this are additional variable expenses in the way of ordering, receiving, put away, handling, etc. It may not all be product but it all adds up.
In October of this year, we put 30 new hires through a three-module training program on profitability and what drives it. As they were learning each of the functions within the business, they had just finished their 3 weeks of warehouse training and were beginning their counter/inside sales stint. I asked them about their warehouse experience from the standpoint of how many warehouse people and drivers they had seen come and go during the time they were in that rotation. Everyone had seen the turnover. One person said that in the time they had been at this one branch, 2 people had left, and 3 people had been hired. This was in a 3-week period of time!
There is no way you can provide an excellent customer experience when your warehouse personnel and drivers are constantly turning over. This leads to the final point I’ll make on giving away price. The largest area of turnover most distributorships have is in their warehouse workers and their drivers.
Now, in this simple example, considering the high level of turnover, if every invoice was $1000, we would have to process an additional 14,164 invoices a year and potentially make an additional 14,164 deliveries.
If this is ones’ reality, would they even have the capacity and capability to provide an excellent customer experience?
This is the reason why ‘Margin’ conversations are so important. Companies don’t spend sales dollars. They spend margin dollars.
So, what happens when we increase our price by 1%? Let’s take a quick look.
In this scenario above, not only does the company make $2,000,000 in Net Income dollars, but they could sell $12,606,061 less in sales and still break-even.
This also means you could process over 12,000 less invoices and still break-even. There is not as much turnover, your customer satisfaction increases and your Net Income % of Sales grow. Imagine selling at your current volume and growing those numbers by 1%. That would be incredible.
There are plenty of conversations around 1%. Almost none of the people we have talked to have equated their selling habits with the direct negative impact (in this scenario) they are having on the company as a whole; and, more specifically, their fellow employees. It’s a mind-blowing experience when we begin to break this down. And, where sales professionals receive bonuses on their sales efforts, traditionally operations professionals usually have their bonuses based on company performance. When a company is losing Net Income Dollars and having to spend millions to pay for the extra materials to cover the additional sales needed to just break-even, there is potentially no money to support the growth of the organization or the employees that work there.
On the flip side, if those who impact the margins most understand and can visualize the difference, what an opportunity. Hence the reason for seeing the previous from the minus/plus perspective.
We were working with a distributorship in the Southwest. The inside/counter person received a call from a contractor. They needed a $7.00 part. In order to provide an excellent customer experience, this sales professional discounted the $7.00 part and sent it to the customer in an empty company van 50 miles to deliver the package. When we had the conversation around break-even this scenario was brought up. He was surprised to know that the company had lost a lot of money on that transaction. The vast majority of our sales and project professionals work with a huge amount of integrity. They just have never made the connection in this way.
Since we started, we have received countless letters from Presidents and CFOs from various companies in North America. The message has been consistent. The ability to help our people understand and visualize ‘why’ we are asking them to drive margin has been significantly impacted because they saw the ‘why’ in the break-even conversation in a way that they had never understood before.
In closing, when we think about sales and operations training, concepts like this are generally never considered. Experience has taught us that the earlier your people understand concepts like these, the better the potential is in driving real net income growth.