This month marks 12 months in our (not-so-new) office – where has the time gone?
It is also about 5 weeks until Christmas and the holiday season. How is your cash flow looking for this coming holiday period? There is still time to get organised to ensure that the post-holiday blues don’t extend to your finances.
One of the simplest things to do is work out how much you can afford to spend, and stick to that limit. Spending more than you can afford now, simply means spending your future earnings, and this then restricts what you can do when your future earnings do come in.
It may not seem terribly exciting to stick to basic rules like “don’t spend more than you earn”, however it is the fundamentals that will help you keep out of financial trouble and ensure that it is indeed a “Happy New Year”.
Over the holiday break, the Value Beyond office will be closed from Wednesday 24 December 2014, and re-opens on Monday 12 January 2015.
How Breaking Even Could Increase Your Profits
Do you know your break-even point? That’s the point where your business makes zero profit or loss i.e. the revenue earned covers all the expenses of the business.
What the breakeven point can identify is the minimum level of sales that are needed in order to keep your business from going “into the red”, or making a loss. If you know what this number is, then you can also use that same process to set some goals for the level of profit you want to make from your business. This in turn provides a budget so that you can understand whether the sales that you achieve will help you meet your goals, keep the doors open, or if you are headed for trouble.
So, what is the break-even point?
The break-even point is the point when sales/revenue, less variable costs, less fixed costs equal zero. That is, after all costs, the business does not make a profit or loss.
Say for example your business’ sales are $200,000, the variable costs or gross profit margin is 50% or $100,000, and the fixed costs are $100,000. this gives a profit of $0.
Variable costs are expenses that are directly related to the sales you make. That is, if you didn’t make the sales, those costs wouldn’t be incurred. This would include costs such as stock, materials, raw products, labour, royalties and other costs that are directly related to sales.
Fixed costs are expenses that will be incurred regardless of whether a single sale is made or not. These costs include rent, salaries (such as administrative staff and director’s salaries), insurance, telephone, electricity, and other office expenses.
Understanding this formula, we can take it and work backwards to set a sales target so that your targeted profit can be made.
Using our example above, if the owner wanted to make $100,000 profit, then to reach that target the sales required would be:
$100,000 profit + $100,000 fixed costs = $200,000 gross profit required.
$200,000 gross profit/50% gross profit margin = $400,000 sales.
To check these figures, $400,000 sales – $200,000 variable costs (50%) – $100,000 fixed costs = $100,000 profit.
Want to make $200,000 profit? The new target is $600,000 in sales.
This example is simplistic and you would of course need to consider if increasing your sales by 300% would require additional fixed costs, such as increased rent from bigger premises, increased administrative salaries, or increases in other expenses.
Regardless, once you have a detailed budget of expenses then the same formula applies.
The best part of this exercise? Once you have worked backwards from your desired profit, you now have a sales target that can be broken down into quarterly, monthly, weekly and even daily targets.
Meet those targets, keep your expenses under control, and you could be well on your way to making the profit you desire.
The Secret of Compound Interest
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
– Albert Einstein
Do you know about compound interest? The concept is quite simple – if you invest money and earn interest, and reinvest the interest earned, then the interest also earns interest. It is this interest earned on interest earned that is the “compounding” effect.
Say, for example, you invest $5,000 at 5% interest. In the first year you earn $250 interest, and reinvest it all. In the second year, you have $5,250 invested so you earn $262.50 in interest. The extra $12.50 in interest is as a result of compounding..
If this money is reinvested for 10 years, then the balance will have increased to over $7,700 and will be earning interest of $388 per year – the total investment has grown by more than 60%, and is earning 50% more interest than in the first year.
So what happens if you then add just another $500 per year to your investment? The graph says it all:
For a total investment of $10,000 ($5,000 lump sum + $500 x 20 years), the end value is nearly $28,000 and earns $1,400 in interest per year.
The danger of compounding interest lies in the reverse position – when you borrow money. In that situation, compounding interest works against you by charging interest on interest charged, increasing the amount you owe with every period that passes.
Given the power of compounding interest, how do you take advantage of it?
Firstly, ensure that you are paying off debt that might have compounding interest working against you. This would include high interest credit card debt, where the minimum repayment doesn’t even cover the amount of interest being charged each month. By not clearing credit debt at the end of each month you could quite quickly see yourself in a debt spiral.
Secondly, start investing. While you can get caught working out the best time to enter any investment market, or what the best investment is, as long as you are invested and are earning and reinvesting returns from your investment each and every year, then compounding will be working for you.
Finally, start now. The biggest factor in compounding is time. The longer you are invested, the less you need to invest upfront, and the less that you need to add to your investments to reach the same target. Don’t believe it?
Start with $10,000 invested at 5%, and add $1,000 pear year and in 30 years that investment will be worth $109,000. Start only 10 years later and you would need to add $2,500 per year to reach the same goal. Start with only 10 years remaining and you need a lump sum of $30,000 plus a whopping $4,800 added each year!