The main reason for having a business is to make money. In business terms, the money you make is the net profit you achieve at the end.
Net Profit = Total Sales – Total Expenses
This is a very basic but highly important equation for every business operation. To start making profit, your total sales (revenue) needs to be higher than your total expenses.
This means that you need to achieve the following 2 key points:
- Increase your Total Sales and keep them higher than your Total Expenses
- Control and Decrease your Total Expenses and keep them lower than your Total Sales
In order to manage to control your Total Expenses, you need to know the basics about them.
Types of Expenses
Your Total Expenses are the summary of the Overhead and Variable expenses your business has.
Total Expenses = Overhead Expenses + Variable Expenses
Overhead expenses are all those business expenses which do not generate any sales but are absolutely essential for a business to operate.
They have to be paid even if the business is making no money at all.
There are different types of overhead expenses:
Fixed Overhead Expenses (Fixed Costs)
A fixed cost does not change in relation to the sales a business is making. They are also known as non-controllable costs because they cannot be changed easily and quickly by the business management.
Main costs in this category are the rent, council tax or property tax bills, insurance premiums and equipment depreciation.
Another fixed cost is the wages paid to the team members who are on a salary rather than hourly rate (Managers, Head Chef, etc.).
The minimum level of energy like gas and electricity, which is required for a business to operate regardless of the sales, is also considered to be a fixed cost.
Variable Overhead Expenses
These are overhead expenses which are connected to the business activity and total sales. The busier you are, the higher they go.
Main costs in this category are marketing and advertising costs, office supplies, equipment maintenance and consumables like cleaning materials and chemicals.
Periodic Overhead Expenses
These are the types of overhead expenses which are very difficult to plan as they happen infrequently.
They are usually unexpected and they can include things like an equipment replacement or repair.
These are the types of expenses which are directly related and connected to the total sales. They are also known as controllable costs because they can be easily changed in the short term
One of the main costs in this category is the labour cost for staff on hourly rate. The higher the sales, the more people are needed to work, the higher the labour.
Another main cost in this category is the Cost of Goods Sold (COGS). This includes the cost of all the ingredients used for food and drinks production and also all the individual products sold without any further preparation or change in their original form. In hospitality, this is known as the Food and Drinks Cost.
Any additional amount of energy used over the minimum level of which is required for a business to operate, is also considered to be a controllable cost, as it is related to the amount of sales the business is making. The more food you sell, the more gas you will spend to cook it.
This is the key point for every business to be aware of.
Break-even point is the point at which the Total Sales are equal to the Total Costs (Overhead Expenses + Variable Expenses).
Total Sales = Overhead Expenses + Variable Expenses
The break-even point shows you what amount of sales you need to achieve in order to pay all your expenses. At this point the amount of profit, but also the loss, are zero. The business will start making profit after this point, when all the expenses are covered by the sales.
A basic example is the following:
In a week, a restaurant has spent £2500 on labour, £3500 on food cost and the total overhead expenses are £1500. These expenses total £7500.
The break-even point for this restaurant is £7500 in sales. Any amount of sales over this amount is the net profit for the business.
Knowing the types of expenses your business has, is the first step in order to be able to control them to the best possible point.
Make sure you know your break-even point, this is when you will know that you are making profit.
My advice is to be organised and keep records of everything you spend. Having a knowledgeable and experience accountant is the best course of action, it is hard to keep up with all the legislation which is changing all the time, but also they will be able to help you save money, if they know what they are doing.