Every so often I hear of a business owner, or new entrepreneur who has been advised to "sell at any price" or "just get any sale you can to get you going". No matter how well meaning it is, that’s bad advice. You should never agree a sale unless you’re going to make a profit from that sale^*.

The reason for this is simple; if you’re only breaking even on a sale then your business is not generating any profit, with no profit you’re not going to be able to invest in the business and slowly but surely the business will begin to die off. Worse still if you’re selling at a loss you’re using up the businesses cash. As a result the business will eventually run out of cash and fail.

Unfortunately far too may entrepreneurs and small business owners sell at or below their break even price without realising it. Lets consider for example a company doing software development. They charge their clients £300 per day for their services and regularly use freelancers/contractors to develop the software. These contractors cost them £200 per day, but the contractors are only paid for days worked on client projects.

But they’re making a profit I hear you say. Well yes at first glance it does appear that the business is making a profit of £100 per day for each day of work it sells and in accounting terms that would be referred to as the gross profit. However it’s not the full story. If we look at the business in more detail we’ll find that there are two founders who spend their time doing sales, marketing and general administration. The founders hope to draw a salary of at least £30,000 each from the business, they have a small serviced office that costs them £200 per month, they spend £80 per month of mobile phone calls, £30 per month on postage, £100 of miscellaneous items and £200 per month on advertising. Thus their total monthly outgoings are £610 in expenses and £5,500 in salary (60K split evenly over 12 months and adding in roughly the cost of National Insurance). So their total monthly outgoings are £6,110, or £305.50 per day.

That £305.50 per day is what accountants refer to as overheads. Any sales they make need to provide a contribution towards the cost of the overheads. So in order for the business to break even they need to generate £305.50 of gross profit EVERY day, in other words they need to generate revenues of just over £900 per day (£234,000 per year) to break even. They’ve both worked flat out however and between them they manage to generate a little more than that last year. In the current economic climate they feel pressured to take any sales that are offered and start to accept work at £250 per day, after all they’re still making £50 per day gross profit which isn’t bad in a "hard" market, or so they think.

Unfortunately what they’ve really done is begin to kill off the business. Having halved their gross profit they will now need to double their sales revenue just to maintain their break even level for the business, but they’re both already working flat out and don’t have any spare time to generate the extra business themselves.  So to double their revenue they would need to employ additional sales staff and possibly increase the amount of marketing they’re doing. This in turn would increase their overheads further decreasing their gross profit and raising the overall revenue needed to break even.

On the other hand had accepted that they will loose price sensitive clients and put up their prices to £350 per day they would only have needed to generate just over £700 in revenue per day to achieve break even. In short don’t make a low profit sale just for the sake of making sales, fewer sales at higher profit levels are almost always better for your business.

*  There are of course exceptions to this rule, sometimes you may have to sell at a loss. These exceptions are usually related to fixing a mistake your business previously made, i.e. buying too much stock and needing to free up some cash quickly in order to stay in business.

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