(BEP) = Fixed costs ÷ CMR
BEP = $187,588 ÷ 0.2406
BEP = $779,235
This means that if actual fixed costs meet the budget, the company will begin to generate a profit when revenues exceed $779,235. How much of a profit will be made is revealed by using the following (and final) formula:
Profit = (Revenue—Break-even revenue) × CMR
Profit = ($900,000—$779,235) × 0.2406
Profit = $120,765 × 0.2406
Profit = $29,056
Even though actual revenue exceeds break-even revenue by more than $119,000, the actual profit is far less because the difference was used for direct and variable costs spent generating the additional income.
For most contracting businesses, the ideal time to reach the break-even point is in early fall; doing so leaves several months to generate a profit. If the break-even point is reached in December, for example, the profit will likely be small. Study Figure 7–2 on page 91, and it should become clear.
Figure 7–2 shows how revenues and expenses grow during the year. Total costs, which include direct, fixed, and variable costs, are shown by the line with arrows. Revenues are shown by the line with tiny x marks. In the example, revenues begin to exceed costs during the month of August and remain ahead of costs for the remainder of the year, resulting in a profit for the company. Of course this is assuming a fairly steady work flow with similarly sized jobs throughout the year. You could have a major job, your largest of the year, in May and June, bringing you past your break-even point much earlier than expected. This can give you an opportunity to allow early profits to grow by year’s end.
FIGURE 7–2: Break-Even Analysis
Establishing a budget, understanding and using contribution margin, and correctly allocating expenses among direct, fixed, and variable costs are only the first steps in implementing a successful budget and estimating system. In order to be successful, expenses and revenues must be monitored on a regular basis and adjusted if necessary. The budget should be reviewed at least monthly for most small contracting businesses and at least quarterly for larger companies. A budget is not a static document but is subject to change and modification during the year. A change in the budget may necessitate a change in the way products and services are estimated, resulting in a price change. The sooner that a company can determine that expenses are not meeting budget expectations, the sooner pricing can be adjusted to reflect the discrepancies.
Figure 7–3 on page 92 is an example of monitoring spending on a monthly basis. Spending through September is compared with the 12-month budget. Column 2 lists the amounts, by category, that are budgeted for the entire year; column 3 lists the amounts actually spent as of September 30; column 4 indicates the percentage of the annual budget that has been spent. Because September represents 75 percent of the year, the expectation is that most expense categories be close to this figure. Amounts that are far over or far under the budget should be analyzed further.
FIGURE 7–3: Budget Analysis
Get a checkup using a spreadsheet set up like this to compare your budget to actual expenses.
While several items are over budget, the totals for each category are acceptable; total direct costs are 76 percent of budget, fixed costs are right on budget at 75 percent, and variable costs are under budget at 68 percent. Two items are worth considering in more detail. Utilities have an annual budget of $1,800, but $1,550, or 86 percent of budget has been spent. An analysis may show that seasonal temperatures caused utility expenses to rise earlier in the year, but they are expected to drop in later months. The uniforms expenses are at 100 percent of budget. Here, an analysis may indicate that new uniforms were purchased in January. No more uniforms will be purchased before the end of the year, so the annual expense will meet the budget. In the example of Figure 7–3, it appears that total spending is very close to the budget, and there is no need to adjust the pricing formula.
A second method of tracking the success or failure of company operations has little to do with the budget or with contribution margin. However, it is a useful tool, especially when used over the course of several years. This method compares actual revenues with real field labor costs, which are regular wages plus overtime costs. It is unnecessary to add labor burden to the calculations. Wages of office staff, sales staff, and executives are not included as they are not direct job costs. Consider Figure 7–4.
As shown, at the end of September 2013, revenues were $580,000 and total wages were $127,500. Therefore, each dollar spent on field wages generated $4.55 of revenue. In 2014, the amount generated dropped to $4.45, but it rebounded in 2012 to $4.59. For some reason, efficiency dropped in 2014; there could be any number of reasons for this drop, and they aren’t necessarily all bad. It may be that the workforce did work less efficiently and took longer than expected to complete projects. It may also be just a quirk in the calendar—perhaps there was an extra pay period in 2014 or, possibly, several projects were near completion at the end of the month and their revenues are not factored into the equation. But whenever there is a drop in efficiency as indicated by a reduction in sales-per-labor dollar, it is necessary to learn why the drop occurred. Any drop in efficiency is a red flag that may indicate a breakdown somewhere in the company. Perhaps the estimating department did not realize that there was a price increase in materials, or new employees are taking too long to learn their tasks, or the billing department is tardy in sending invoices for work completed. Whatever the reason, it must be corrected immediately.
FIGURE 7–4: Sample Spreadsheet to Analyze Sales per Labor Dollar
Tracking expenditures and revenues on a monthly basis and comparing them to the annual budget and to previous years’ spending is a fairly simple task that should be done on a monthly basis, shortly after the end of each month. Routine financial check-ups will usually prevent serious problems that can have a negative impact on a company’s bottom line.
