The fast food workers' strike was hilarious, proof that they deserve low wages. If you want better wages, get a better job. That's the way the U.S. economy has worked since...since forever. Of course, you might have to get some training. If you aren't improving yourself, you deserve the job and the wages you have. I'm the wrong person to gripe to about this. I paid for my own college, additional night courses, and CPA exam review course. Your job situation isn't my problem. Your job situation is your problem. President Obama's "less fortunate" is really a euphemism for "lazy." If you don't know what a euphemism is, give me fries with my burger, please.
Once you identify a business to purchase, you determine how and whether you can make money in the business with break even analysis. Break even analysis reverse engineers the historical financial statements of a business to determine the level of sales necessary to not lose money. Above that level, you make money. Below that level, you lose money.
I suggest using an average of the three most recent years of either the business tax returns or profit & loss statements. Use either the tax returns or the financial statements. Don't mix and match. Sometimes the tax returns are on the cash basis and the P&L's are on the accrual basis. You want apples to apples.
First, divide the expenses of the business into two categories: variable expenses and fixed expenses. Variable expenses are expenses that increase when sales increase and decrease as sales decrease. For example, the food costs of a restaurant are variable expenses. Materials are a variable expense of a home remodeling company.
Then subtract each year's variable expenses from yearly sales. That is gross profit. Next, divide gross profit by annual sales to get a percentage. That percentage is your gross profit percentage. Average the percentages from the three years.
Fixed expenses don't vary with sales. Rent is normally fixed in amount. For the most part, so are the salaries of a restaurant. Another word for fixed expenses is overhead. Ignore non-cash expenses such as depreciation. Total the fixed expenses for each year and then compute the average.
With the average gross profit percentage and the average fixed expenses, we have the inputs to determine the break even annual sales. We simply divide the average fixed expenses by the gross profit percentage. That gives you the annual break even sales amount. Simple enough? The most important task is next.
Determine if the break even annual sales level is realistic. If the break even number is $600K, but the business has never grossed more than $400K, what are the chances you can increase sales to get to break even, let alone profitability?
If the break even sales level isn't realistic, don't bother going further into the purchase process. Flush this turd, and move on to the next opportunity. If the break even sales level is realistic, use the model we have developed to determine how much in sales you need to make your desired annual profit. This formula is a simple derivation using our break even formula.
This time, instead of dividing fixed expenses by gross profit percentage, add your desired annual profit to fixed expenses before doing the division. This gives you the sales level necessary to reach your profit goals.
If this sales level is realistic, you are ready to consider making an offer. The next step is determining the offer. I'll cover that in my next post.
As always, thanks for reading! For real tax and accounting advice, please visit the main S&K web site at www.skcpas.com. Also, please like the "How to Screw Up Your Small Business" Facebook page. I post snarky business tips several times daily.
Until next time, let's do it to them before they do it to us.
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