It was the opening day of the consulting engagement, so my client and I were reviewing costs, expenses, sales income and related activities. In other words, reviewing where his company was on that day and how it got there. The usual stuff.
When reviewing some of his recent jobs, he showed me one that was completed just days before. He said that he just “broke even” on this job.
I took the opportunity to ask him how he defined Break Even. He replied that his customer paid just enough to cover materials and labor costs. I told him that he did not break even, but actually this job was a loss. He asked me because that could be if his company was able to pay for the materials and labor. My response was simple. I told him that yes you did pay for the materials and supplies, and you did pay the employers, but it was your company that did not get paid.
He asked me what I mean by that, so I told him that this completed project that he thought was an even break actually contributed nothing to the fixed expenses such as rent, utilities, telephone, internet, and other expenses that are required to keep the business alive and well. Consequently it was a loss.
My client's understanding of the Break Even Principle and the components required to determine an accurate Break Even price were all too common. Most small business owners are of the opinion that Break Even consist of of covering Direct Costs only and not Fixed Costs and Overhead. To break even, Direct Costs and Fixed Costs must be considered and covered.
But it does not stop there. A Break Even Price strategy must address Volume and Capacity conditions or shortcomings. Volume and Capacity are keys to achieving and maintaining a routine Break Even status that is on or ahead of plan.
Volume and Capacity must be considered in addition to covering Direct and Fixed Costs. Volume is determined by the Revenue Stream. For my client, Volume was supported and maintained by how many projects were running day-to-day, month-to-month, and quarter-to-quarter. For other types of businesses, Volume would be supported and maintained by sales or other revenue producers.
Capacity for my client was measured by how many crews were working. Many business owners and particularly those who depend on union labor want to keep good workers on their payroll. So if four jobs are running and the company has five crews, then somehow and somewhere one crew has to working on one or more of the four projects underway. That adds to Direct Costs of each of the four projects, but also saves good workers. Such are the challenges of the small business owner. The challenge for my client was how and where to absorb or offset the extra costs.
There are ways.
One of the most successful methods is to finish projects ahead of schedule. Projects finished just one day early can have a significant impact on both Revenue and Capacity.
Proper job site management always saves money. Even the best estimates are won or lost at the job site and now else!
But those are discussions for another day.