Remember, too, that these expenses are only the ones you can anticipate. Starting a new business usually takes more money than you expect. Allow yourself a buffer for unforeseen expenses.
Break-Even Point
Another crucial step in planning for the financial health of a new business is calculating your break-even point. Your break-even point is how much income you need monthly to pay all of your bills including payroll.
Monthly Break-Even
To calculate your break-even point, begin by adding all your obligatory expenses.
Some expenses, such as FICA and SE taxes, are annual expenses. Others, such as insurance premiums, may need to be paid semiannually or quarterly. If an expense comes due annually, divide that annual expense by twelve to calculate monthly break-even. If an expense comes due quarterly, divide by three. In other words, calculate expenses on a per-month basis.
Some people like to add their own monthly salary into this equation. Others figure it separately. If, just to stay afloat, you must get some money out of the business for yourself, add a minimum salary into your calculations. If, at least at first, you have other sources of income to meet your personal needs, calculate your salary separately.
Always estimate expenses a little on the high side if you want to avoid unpleasant surprises. The sum of your expenses is the minimum amount of money you will need to take in each month. It is your “break-even point.”
Number of Students Needed to Break Even
Another way to keep track of your break-even point is to think of it in terms of how many students you need to pay the bills. That number, of course, depends on how much you expect each student to spend. Besides tuition, several other expenses come into play in this calculation. How many seminars or tournaments will each student be participating in? After expenses, what could you expect to earn per student on these events? Will you have a formal ranking or certification program? If so will you charge for each promotion? How much do you expect to earn from promotion fees? Do you plan to have a retail area? If so, how much can you expect each student to spend on uniforms and gear each year? How much of that income can you keep as profit?
Add each of these additional sources of income to your yearly tuition to get your annual per student income. Then subtract any per-student expenses you might have. For example, you may get $200 per student in testing and promotion fees each year, but spend $50 of that on certificates, registration with the state or national organization, or emblems-of-rank belts, patches, or a plaque on your school wall. Subtract these annual per-student expenses from your annual income. Then divide the remainder by twelve to get your monthly per-student income.
To calculate the number of students you will need to break even, divide your total monthly expenses (your break-even point) by your monthly per-student income. For example, let’s say you need $3,000 each month to break even. Your monthly per-student income is $100. You need thirty students just to break even. Those first thirty students pay the bills. Every student beyond thirty (your break-even number) adds to your profit.
If you eventually also want to make a salary for yourself, you’ll need to figure that into your calculations, as well. Divide the monthly salary you would like to be making by your monthly per-student income, and that will tell you how many more students you will need to pay yourself. Add the two numbers to get your target enrollment number.
Be aware, however, that “target enrollment” is not the number of students you will need to sign up. Target enrollment is the number of paying students you need every month to pay your bills and yourself. To keep your school at its target enrollment, you’ll need to sign up not only enough students to pay the bills; you’ll also need to sign up new students to compensate for those who drop out. Remember, too, that we’re talking about paying students, not training students. If they don’t pay, they aren’t a part of your target enrollment.
A word about the future: While you’re figuring out expenses, also look at “optional” expenses. For example, you may eventually want to be able to hire an employee. You may want to expand your school. Consider, too, your own continuing education: you may want to set aside money for seminars and teacher-training classes. Sure, at the beginning, you will probably be glad if the business makes enough to support itself. Eventually, though, you may want to run not just a self-supporting business but a thriving one. To figure out how many students you would need to support additional expenses, you can use the same formula. Monthly expenses for your optional projects divided by monthly per-student income equals number of students needed to support the optional projects.
Calculating your break-even point and additional expenses in terms of target enrollment makes those expenses “real” in a way numbers can’t: “I need thirty students to break even. No more than twenty of my regular students have been training this month. I need to check to see if I can repair the problem before next month’s bills come due.” “To hire a part-time employee to manage the office, I need ten more paying students.” “To afford the expenses at a new location I need another twenty-five students.” In other words, if you think of your break-even point in terms of number of students, you can look at your monthly sign-up, attendance, and payment records and get an immediate, intuitive sense of whether you are getting closer to your financial goals.
Your First Two Years
In the early months, while you are still building your student base and trying to reach your target enrollment, you will need outside funding to meet your monthly expenses. As a rough estimate, assume that for the first six months you will be paying nearly all your monthly expenses out of pocket. That means before you open your doors you need to know where you will get those first six months’ operating expenses.
Assume that after those six months are over, you will still have to pay out of pocket for some of your operating expenses for up to two years. Why? Statistically, you will not be making a regular profit for two years. Sure, you will have profitable months before then. But you may need two years to figure out what your annual business cycle will be. You will probably need two years to learn to anticipate slow months. And you will probably need two years to save enough reserves to weather them. In short, it normally takes two years before you are out of the building stage of your business and into the maintaining stage. Of course, you might hit a steady target enrollment before then. Some businesses are self-supporting in a year or less. But though you can hope to be out of the building stage in a year, though you can work toward that goal, you should plan to have backup funds available for two years.
How do you handle the financial demands of those first two years? One way is to get a business loan for just start-up costs. You then set up a revolving credit line with a bank or private lender for initial operating expenses. You can draw money from the credit line as you need it, and repay the debt as you have extra profit. Another option is “bootstrapping.” You borrow the start-up costs and keep your day job to meet your living expenses, maybe even to help pay some monthly business expenses, while you’re growing the business. Whichever option you choose, make sure you know where you will get the money for those early operating expenses. You don’t want to get desperate and eat up your family’s nest egg.
Discover Sources of Money Available to You
You will probably finance your business from two sources: equity and debt. Equity