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Gestation period, dreaded by most entrepreneurs, accompanies the first joy of starting any business venture. Success follows it or else it tolls the death knell. However, a well-conceived business plan can help avoid any such debacle.
The breakeven point is a crucial juncture for any business project at which the volume of sales or revenues exactly equals the total expenses. It is the point when the business stands on its feet though it doesn`t make profit neither incur loss. This point underlines the essential requirements that are must for the much elusive profit for the organization. It reflects the relationship between costs, volume and profit.
An entrepreneur, with much zeal, starts his own business, but how many of them survive in the long run? Sixty-five per cent of such startups die a premature death. Such degeneration occurs because of the lack of correct business plan, as a result never reaching the breakeven point.
Till this point, the total expense is always higher than the total revenue. The business is run by borrowed money or that comes from the owner`s pocket. This is the general feature for any home-based business. When a business reaches the breakeven point, the business is self-sustaining and appears on the verge of being a viable business. However, even at this point, the owner doesn`t make any profit but it is the acknowledgement of the business`s success.
Breakeven point or gestation period varies from sector to sector. A gestation period of jewellery shop cannot be the same as a beauty parlour or a medicine shop. In this regard, Shashank Pathak, Vice President (Retail), Gitanjali Lifestyle, takes a critical look at the issue reiterating that “the retail industry has various formats and the gestation period varies from format to format. In jewellery retailing, generic durations vary from 18 months to 24 months, which totally depends on the top-line achievement leading to performance”. Elizabeth Scheurer, National Training Administrator, Just Cuts, an international chain of hair-cutting salons, tells that a salon like theirs goes through a period of two-six months till it reaches the breakeven point, considering the locality where the shop stands and steady traffic flow. For a medicine shop, according to Ashutosh Garg, Chairman and MD, Guardian Pharmacy, it varies from 12 to 18 months. Again, Sanjay Shroff, VP (Finance), Yo! China, informs that a fast-food outlet like theirs starts to break even by the 4th month. The ROI generally is achieved within the range of 3 years to 4 years.
While analyzing breakeven point, one has to take into account the fixed costs like rent or equipment leases and variable costs like cost of supply, salary expenses, sales commissions or any expenses that change from month to month.
One can analyse breakeven point by a formula:
P = U(p–V)-F
Where P is the profit, p is price, U is units sold, V is variable costs and F is fixed costs.
For example, if a businessman wants to sell a product for Rs.10.00 and wants to sell 1,000 units of it, the total fixed costs go up to Rs.7,700. The total variable costs remain Rs.4.50/unit. According to the formula, then
P = 1,000(Rs.10-Rs.4.50)-Rs.7,700 = – Rs.2,200
The analysis shows instead of making profit, the company has suffered a loss. At breakeven point P should be 0. It clearly shows that selling 1,000 units will never bring the desired result.
Now, if P = U(p-V) – F = 0, then U(p-V) = F or U = F/ (p-V), i.e. Rs.7700/(Rs.10 – Rs.4.50) = 1400 units. So, if we maintain our price and expenses, we need to sell 1400 units of our product to break even. If we raise our price or reduce expenses we can sell less.
One must remember that the breakeven analysis does not show profitability. It will only show some levels of profit at various levels of sales.
(Source: www.smalltownmarketing.com – How to do a break-even analysis)
Stages leading to breakeven point
Now, let`s have a look at the various stages that eventually lead up to the breakeven point. Pathak of Gitanjali Lifestyle explains, “Whenever a Business Plan is made, it is broken down into detailed quantitative numbers starting from 3 years projections to yearly, monthly, weekly, category, brand budgets. Each sheet has a number for the day for the Brands` performance or format`s performance. An increase in Top-Line (more than the budgets) also indicates escalation on costs; hence a Ratio Method is important to set the right parameters. It is important to have an independent entity monitoring these factors on monthly basis, sharing it with the drive team and recommend and implement corrections.”
The initial stage is the Month-to-Month breakeven point. It is the stage when expenses are on record, not the profit. Gradually the business develops. This becomes conspicuous with the decline of the personal investment. This leads to the next stage – Cash-in-equals-cash-out breakeven.
At this point, the business no longer needs to be subsidized. Here, the business owner starts to take out a considerable chunk as a livable wage but not making the profit since the amount itself constitutes the livable wage. However, it signals that the business is on the threshold of making profit.
It comments over the business acumen of the entrepreneur. It is an achievement. Such a person has learnt to overcome the challenges of his business inside and out. But one should remember that the point must be reached before the owner`s cash contributions run out.
Once the business reaches this point, the assurance of its survival becomes almost certain. But remember – the entrepreneur has now bought the business. The business is drawing its sustenance out of it and the entrepreneur is earning his livelihood, but what about the money that has been invested? Is it lost forever? Does he really want to run a business that requires personal maintenance day in day out in the coming years?
This gives us the cue to the final breakeven point – from day one to today.
Now, the entrepreneur wants to move from buying a business to owning a business, from livable wage to respectable wage. This point ensures that the entrepreneur starts to earn enough profit to reimburse whatever investments he has made with leftover assets. These assets can be invested for the additional income for the business or the owner.
Measures to expedite the process
Next comes the issue – how we can cut short the gestation period and expedite the process to reach the final breakeven point.
Firstly, one should manoeuvre to increase the sale without major increase in the advertising or promotional expense. This can be done through free publicity in the sale area, like convincing an industry expert to give a free seminar or tying up with an important event and then informing the newspapers about the event. Secondly, a possible way has to be found out so that the prices of the products can be raised without losing the customers. For this one can position his products away from the competitors and add a uniquely-conceived value added services. Think about Domino`s Pizza`s “30 minute delivery”. It had hit the bull`s eye. Lastly, cut down the unnecessary expenses that you can do without. Expensive offices, excessive bonus can come later. For example, retail giant Wal-Mart has their head office at Arkansas, instead of any costly notable cities like New York or Chicago. According to Garg of Guardian Pharmacy, it is the high rental that works as the impediment in the way to attain the much-coveted breakeven point. So, getting a retail space at reasonable rental should be the primary concern in the context of present scenario. The same is echoed in Shroff`s words ¬– “Given the high rents prevalent in the market, it is really tough to expedite the process. In the current scenario, the rent works out to 25% of sale. Ideally the rent should not be more than 12%.” Also, for the shops in a mall, he opines, the success depends partially on the success of the mall.
Nevertheless, some factors definitely play a major role to attain the breakeven point as early as possible. In Pathak`s words, “The process of gestation is a very closely monitored factor in every retail format`s performance. Each budgeted factor of Sales, Costs and corrected future projections gives clarity of our progress. We need to understand the current trends to view the deviation from the projected Gestation Period and expedite a plan of action to achieve it earlier than planned for best performance.”
Gestation period is a crucial phase for any business since it stands for the vital purpose of making profit. One must have enough money to withstand this infertile period. Gestation period lingering more than its usual time phrase gives an ominous sign to the entrepreneur. If it stretches beyond the stipulated time, it is the time to decide whether to continue before the fund dries up. Pathak points out, “Besides well-calculated gestation period, other factors are also needed to compare the benchmarking processes in the relative industry across the globe and country, and for the competition in the city. It is important that we compete with the retail environment and break even as planned.” Therefore, it is the inevitable gateway one has to cross to tread on the path that leads to success.