Understanding and Calculating the Break-Even Point in Franchising

This term is a vital indicator for any business. Comprehending how to calculate it can impact your franchising journey. Below we will help you work out your break-even point using a simple formula. But before we go any further, let's refresh our knowledge of what it means when a business ''breaks even''.

The Concept of Breaking Even

In simple terms, the break-even point in a franchise business refers to the total revenues equal to total costs. In other words, it's the point at which your franchise neither makes a profit nor incurs a loss - it ''breaks even''. This milestone marks the transition from initial investment recovery to potential profitability.

Break-Even Point

For instance, if your franchise is a coffee shop. The break-even point would be the number of coffee cups you need to sell to cover all your costs. These will include rent, wages, coffee beans, and other expenses. Every cup sold beyond the break-even point contributes to your net profit.

Calculating the break-even point can assist franchise owners in setting sales targets and pricing. It can help them make informed financial decisions.

Deadlock Point

On the other hand, the deadlock point is a financial metric expressed in time rather than revenue. It refers to the length of time a business can sustain operations using its existing cash reserves without any extra revenue.

In other words, it's when your cash flow will no longer cover your operating expenses, leading to a 'deadlock' in operations. Understanding the deadlock point is crucial in managing the cash flow of a franchise. It indicates how long the business can continue operating without additional income.

This metric is handy in uncertain times or periods of slow business. For instance, knowing your deadlock point can help you plan. You can make decisions to ensure business continuity if your franchise enters a slow period.

Calculating the Break-Even Point in a Franchise

Calculating the break-even point in a franchise involves the following key steps:

Determine Minimum Revenues

It is the least amount of revenue your franchise must generate to cover all expenses and avoid losses. It factors in both fixed and variable costs, which we'll discuss next.

Calculate Total Revenues

It is the total income your franchise generates by selling products or services. It might also include other forms of income, such as licensing fees or royalties.

Fixed Costs

These are constant costs regardless of the amount of goods or services produced or sold. They are expenses that franchises must pay, independent of specific business activities. A great example of this is rent.

Variable Costs

On the other hand, variable costs do depend on the sales volume. They increase as production rises and decrease as production reduces. An example of this is the cost of packaging and raw materials.

How to calculate your break-even point?

To even be able to begin to answer: ‘When will be franchise break even?’, you need to use a break-even point formula.

Fixed Costs ÷ (Price – Variable Costs) = Breakeven Point in units

Let’s break down what this means ...

The break-even point is the same as the total fixed costs divided by the difference between the unit price and variable costs. With this formula, the fixed costs are the total of your overhead costs. The variable costs and price are stated per unit costs, in other words, the price for each product unit you sell.

Price – Variable Costs are also known as the contribution margin. It is used to find the optimal price point for a product. It can also show you whether the product generates sufficient revenue to pay for the fixed costs and determines the generated profit.

Let’s use an example to demonstrate how this works in the real world.

Case Study 1: B2B Business

Consider a hypothetical B2B software franchise named 'TechForge.' This franchise sells software licenses to other businesses.

The franchise has fixed costs of £375,000 per year. It includes expenses such as the franchise fee, rent, and staff salaries. Each software license sold incurs a variable cost of £150, which covers software development and maintenance costs. The selling price per software license is £375.

Using the break-even formula: Break-Even Point (Units) = £375,000 / (£375 - £150) = 1,666.67.

So, TechForge must sell approximately 1,667 software licenses annually to break even. Any sales beyond this point will contribute towards the profit of the business.

Case Study 2: Franchise Reselling Business

For the second case, let's examine a franchise reselling business. This business focuses on buying existing franchises and reselling them for profit.

The fixed costs, which include employee salaries, office rent, and utilities, total £600,000 annually.

Every time the company purchases a franchise to resell, it incurs a variable cost of £37,500. The average selling price for these franchises is £75,000.

Applying our break-even formula: Break-Even Point (Units) = £600,000 / (£75,000 - £37,500) = 16.

It indicates it must buy and sell approximately 16 franchises annually to break even. Anything sold beyond this would be a profit for the business.

Why is working out the break-even point important?

There are many benefits to calculating this, including:

1. Allowing you to work out how profitable your current product line is
2. Determining how far sales can decline before you start to incur losses
3. Helping you set fair prices
4. Set sales budgets
5. Giving you a chance to prepare and adapt your business plan
6. Determining how reducing the price or volume of sales will impact the profits

If you can’t break even

If you have found out that your break-even point is higher than your expected revenues, you will need to relook at your business plan and decide what aspects can be changed. You could find an achievable break-even point by:

1. Finding a less expensive supplier
2. Using remote working to cut out rent costs
3. Selling your product/service at a higher price.

Are You Ready to Break Even in Franchising?

Understanding the concept of the break-even point and calculating it are critical skills for a franchisee. Yet, reaching this point does not guarantee future profitability. It can still form part of an important milestone for a profitable business. Equipping yourself with the knowledge and skills to calculate your break-even point can be a decisive factor for success.

Remember, the goal of your franchise should be not to break even but to surpass it and generate profits. By comprehending the financial aspects of your franchise, you'll be well-placed to make strategic decisions that steer your business toward sustainable growth and success.

If you’re ready to start your franchising journey, explore our UK franchise directory to find the perfect opportunity for you.

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>> Read more:

• Trying to Finance a Franchise Without Money? Here Are Some Funding Options to Consider
• Financing Your Franchise: How To Get Help From Your Bank
• Franchise Finance - Do The Numbers Add Up?
• Franchise Funding and Finance

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