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Break-Even: It's Like Having Your Own Financial Crystal Ball

One of my sharpest restaurant clients, always seemed to know, before I prepared his monthly financial, what his profit for the month would be for each of his three restaurants. He was so remarkably accurate, at times I thought he was keeping another set of books on the side.

It wasn't uncommon for him to look at a P&L for just a few seconds and say something like, "this is wrong, we can't be making this much money" or "we should be making more money than this." He was usually right. Sometimes an expense hadn't been recorded to the proper period or after talking to his store managers, he determined that the numbers were indeed accurate but instead knew he had an operational glitch on his hands.

His seemingly uncanny knack with numbers was really nothing extraordinary once he explained to me how he did it. He had simply (and accurately) calculated the weekly and monthly sales break even point for each of his three restaurants. He also knew how much of every dollar in sales above the break-even point should go straight to his bottom line at various sales levels above break-even.

By knowing just the weekly or monthly sales volume from the three restaurants, he could, with a good deal of precision, come up with how much money he should have made or in some cases lost in each of his restaurants. If the actual profit or loss was much different than he expected, he knew something was out of line.

The Power of Break-Even

If you're not familiar with break-even, it's simply calculating how much sales a restaurant must have to cover all of it's costs for a certain period of time, say a week or month. Some of the advantages of knowing your break even include:

1. It tells you the minimum sales volume your restaurant needs every week or month to have any real chance of making a profit. Knowing only your sales volume can give you a good sense of whether you're making or losing money.
2. Knowing your break-even enables you to respond promptly to sales declines that may put the restaurant in an unprofitable position. During a sales slump, break-even acts like an early warning system. It can tell you that once sales slide past a certain point, chance are you're losing money and you have a real problem on your hands. It's much better knowing that sooner rather than later.
3. Break-even also gives you a tool to quickly estimate your profit or loss for a period of time, with knowing just your sales.

The basic formula for computing break-even is:

Fixed & Variable Costs

There are two basic types of costs in business. Those that stay the same regardless of sales volume, like rent (unless you're subject to "percentage" rent) and property taxes, which are referred as "fixed" costs. There are also costs that go up or down in direct proportion to sales volume, a good example being food and beverage costs, which are referred to as "variable" costs.

A Simple, Yet Accurate Way To Calculate Break-Even

The following is a simple way to determine the break-even point of an existing restaurant. I've used this approach many times and have found it very helpful in quickly calculating a fairly accurate break-even.

It's good to start with several recent monthly or 4-week P&L statements with some wide ranges in sales volumes. If possible, I like to use P&Ls with the lowest and highest sales volume in the past twelve months and also a third one coming from a moderate, middle of the road, sales period.

For example, assume we get the following P&Ls from a quick serve pizza operator. As you can see below, the three months represent the lowest and highest 4-week period's sales in the last year as well as an "average" or typical sales period.

The next step would be to identify each expense category as being either fixed or variable. In this example, variable costs are highlighted in blue and the fixed costs are highlighted in yellow:

You're probably wondering why I've identified so many of the operating cost as "fixed costs" when in fact some can't possibly be fixed at every sales level. One category that sticks out is Store (or hourly)

Hourly Personnel labor costs. While it's true that Store Personnel costs aren't fixed at every sales level, the approach I'm taking here is to short cut the process by making a few simplifying assumptions. Stay with me and I think you'll see what I'm doing and why this quick and easy method will still get you a very accurate break-even.

So that we don't have to do a detailed, time-consuming cost behavior analysis of every single expense category I assume that every cost that is not truly 100% variable in nature is fixed, at least to initially compute the break-even point. After we've estimated break-even, we can then make some assumptions regarding the effect sales volume has on some of the "fixed costs". You'll see in a minute how we account for those "fixed costs" that in actuality do fluctuate, to some degree, with sales volume such as Store Personnel payroll.

What I've done in the right hand column is estimate the cost % for the variable costs and a cost in dollars for each fixed cost based on the historical P&L's. Obviously this isn't an exact science and I use my judgment to get a reasonable number.

For example, notice that I estimated Hourly Personnel payroll at break-even to be $7,500. How I got $7,500 was by noticing that in the lowest sales period (sales of $37,251) actual payroll was $7,324 and there was a small loss on the bottom line. I assume that break-even will require a slightly higher sales and therefore a slightly higher labor cost. Sure, I may be off a few hundred dollars but all we care about is getting close and establishing a starting point. We can always go back and fine tune it later if we need to.

After going through every expense category, we're ready to total the variable cost % and the fixed costs to calculate break-even using the following formula.

If our assumptions are fairly accurate, we can assume that this particular restaurant needs to generate around $40,000 of sales in a 4-week period or $10,000 a week to have any real chance of making money.

Estimating Your Profit Picture

Knowing your break-even is valuable, but look at what taking it a step further gives you. At this point it's very easy to develop a model that suggests how much money you should be making when sales exceed the break-even point. Just put your P&L categories on a spreadsheet and use the values for each expense category that you used in calculating break-even.

Notice that we've estimated an increase in the Hourly Personnel payroll costs as the sales volume increases. We estimated the labor cost increases by using the historical P&Ls as a guide.

You can see that it would be easy to further tweak certain expense categories like "Direct Operating Expenses" and "Utilities" if there appeared to be a correlation between sales volume and expenses incurred in those categories.

Try using this break-even approach with your restaurant. You should find it to be a useful tool for staying on top of your constantly changing profit picture and make people think you're a real financial wizard in the process.