Hey residential contractors! Today, I'm going to talk about your break-even point and what you can do to improve your break-even point, so you can make profits quicker. Enjoy!
Before I can show you how you can improve your break-even point, so you can make more profits. I first have to discuss what a break-even point is. Next, I'm going to talk about how you can change your break-even point. And then finally wrap up this discussion with some key takeaways.
Quite simply, your break-even point is where your total sales equals your total costs. In other words, where your profit is equal to zero. If we look at the graph on the right, you can quite easily see you that the green line is total sales. The red line is total costs and where they meet is where your break-even point is. Anything to the left of that break-even point is where you're making a loss and anything to the right of that break-even point is where you are making a profit.
In the business cost concepts and classification episodes, I talked about two types of costs. I talked about fixed costs and variable costs. We can also plot these types of costs in the graph that I showed you before. And I've done this in this slide. If you look at the graph on the right, you'll see that everything below the checkered line is your fixed costs and everything above the checkered line is your variable costs. And that your total costs equal your variable costs plus your fixed costs. If you're still uncertain about these cost classifications, please go watch the last episodes I did, where I talk about these types of costs. Now that we know where our break-even point is and how it's impacted between our types of costs, as well as our sales,
what we can start looking at is the break-even point formula. The break-even point formula says that net profit is equal to total sales minus total costs. We know that the break-even point has a net profit of zero. So if we put a zero in there and also break down those other variables a little further, what we'll find is that
price times quantity minus variable cost times quantity minus fixed costs should equal zero. The quantity there is the number of jobs you do in a given range. Something important to remember here is that your price is dependent on your markup percentage. So if your markup percentage increases, your price is going to increase.
And if your mark-up percentage decreases your prices going to decrease.
What the break-even point formula tells us is your break-even point is dependent on three things. Namely your markup percentage, your variable costs and your fixed costs. If you start increasing or increasing your market percentage, that has an impact on the slope of your sales curve. If you look at the graph on the bottom left, you'll see that when you decrease your markup percentage, you decrease the slope of your sales curve and as a result, increase the break-even point. Meaning you need to sell more jobs just to be profitable.
If you increase your market percentage, you increase the slope of your sales curve and as a result, decrease your break-even points, which means you need to sell less jobs to become more profitable.
When we look at variable costs and if you remember what variable costs are, these are costs that increase with the number of projects you do. And these are typically found in your estimate. So materials, subcontractor costs and wages. When you decrease your variable costs, you decrease your break-even point. Decreasing your variable costs can be tricky.
And I've shared a few ways you can do that in the slide. First way is to get special discounts from your suppliers. So if you're buying products in bulk, they often give you a special discount that no one else can get. Another way is to reduce the slippage on your jobs. So, if you're submitting those change orders, please make sure that you are getting paid for those and that you're getting clients signing for them and paying for them upfront so that you don't have to bear the costs of those change orders later on the project.
And then the last way I've recommended here is you could move away from variable costs to fixed costs. In some instances that's like moving from waged employees to salaried employees. This is a good segue to fixed costs. Now fixed costs is the easiest way you can change your break-even point.
If you reduce your fixed costs, you can significantly decrease your break-even point. Meaning you can get to profitability a lot quicker. If you increase your fixed costs, this can be very dangerous because it can increase your break-even point quite significantly. And as a result, require that you do more jobs to be profitable.
Something to point out here is if you're a young contracting company it's best practice to try and keep your fixed costs as low as possible. The idea here is if you have high fixed costs and you're a young company, you're going to have to have a lot of capital to cover those upfront costs so that you can eventually get to a profitable state.
Because if you don't have capital there's no way you can cover the loss until you become profitable. Here are some ways to keep your fixed costs low. If you are just getting started, the first one is don't rent an office, work from home for as long as possible. You don't want to get tied down into a lease.
Especially at the site because you're going to have to find ways to cover those costs and it's quite easy to work from home. And then the second way is avoid hiring salaried employees. Salaried employees are one of the most expensive things you can hire at the start of your business. So in always that you can try and avoid hiring employee until you've got enough net profit to cover the cost of those employees later on or in the following year.
So concluding here understanding how your break-even point works can really help you get to profitability quicker. The reason being, if you can adjust your variable cost or fixed costs or move the, the slope of your total sales curve, you can get to that profitability point a lot quicker. So I just want to make a few closing remarks, which is your break-even point is where your total sales is equal to your total costs.
In other words, where your net profit is zero. Your break-even point is dependent on three things, your markup, your variable costs and your fixed costs. And then finally, as a young company, it's very important that you keep your fixed costs as low as possible so that you can get to profitability as quick as possible.
I hope you enjoyed today's video, and if you have any questions, please leave them in the comments below. Thank you very much as always let's go build better. Cheers.