Here’s what you need to know:

What is Making Tax Digital?

Making Tax Digital is all about making tax administration more effective, more efficient and easier for taxpayers, through the implementation of a fully digital tax system.

The roll-out of the initiative has already begun. Every small business owner and individual taxpayer now has access to a digital account that they can use to check their records and manage their details with HMRC.¹

Further changes are planned in the coming months and years; you can see a breakdown of the roll-out and timescales below. Software providers are actively engaging with HMRC to help shape this process and simplify the shift for small businesses.

Making Tax Digital is expected to be fully implemented by 2020. By this time you should see the following major changes to the way you manage and report your business taxes:

• Through your digital account you’ll be presented with a complete picture of your business’s tax affairs and you’ll be able to manage all of your liabilities at the same time, in the same place.
• HMRC will collect and process information affecting tax in as close to real time as possible. This should prevent any tax due or repayments owed from building up.
• You’ll no longer have to wait until the end of the tax year to know how much tax you have to pay.

Who does Making Tax Digital apply to?

The changes outlined in the Making Tax Digital initiative will apply to a wide range of taxpayers, including most businesses, self-employed people and landlords, as well as individual taxpayers. However, HMRC has suggested that the initiative won’t apply to “the small minority who genuinely cannot use digital tools”, or to small businesses with an annual income below a proposed threshold of £10,000.²

This threshold would be based on the firm’s income from the previous year.

The benefits of Making Tax Digital

• Know where you stand – with a full picture of your business’s tax affairs in your digital account.
• Save time – by having access to all your business’s tax info in a single place.
• Save hassle – by managing all your business tax affairs online.
• Plan and budget more effectively – with a real-time calculation of how much tax you owe.

What does Making Tax Digital mean for you?

A new way of reporting information to HMRC

The move to a more digital tax system should come as welcome news to the many taxpayers who already choose to report much of their information to HMRC online.

… are currently submitted online

Source: ‘Making Tax Digital’, HM Revenue and Customs 2015 (accessed 11 May 2016).

The shift to digital should also help to iron out some of the issues that can make the current method of reporting information to HMRC frustrating for business owners.
Specifically, Making Tax Digital promises to end ‘bureaucratic form-filling’ and to ‘remove the risk of missed deadlines and unnecessary penalties’.

The end of the tax return

One of the biggest implications for small business owners is the eradication of the annual tax return. By 2020 most businesses, self-employed people and landlords will instead be required to keep track of their tax affairs digitally and to update HMRC at least quarterly via their digital tax accounts, or more often if they’d prefer. HMRC has said that this doesn’t mean you’ll have to complete a full tax return four times a year; you’ll simply need to provide more regular updates online.³

The introduction of a ‘real time’ tax system means that instead of reporting information on tax returns and paying liabilities long after the end of the tax year, you will be able to see a real-time view of your business tax affairs and liabilities through your digital accounts. This should make it easier to understand how much tax you owe and to budget accordingly.

What next?

The upshot of all these changes is that, if Making Tax Digital applies to you, you’ll be required to use digital tools, such as software or apps, to keep records of your income and expenditure.

HMRC has stated that it won’t provide its own software, but will ensure that basic apps and software products are available. However, many businesses and their accountants will choose to use more comprehensive commercial online software.

These tools use the data from your day-to-day business activity to build an accurate picture of your business’s tax data, highlighting any possible errors and offering prompts for information that might otherwise be overlooked. Once your software has compiled the relevant data, you or your accountant will then submit it directly to HMRC, either via a computer or a smartphone.

We will be happy to talk through the options with you and explain how they plan to work with you as Making Tax Digital is rolled out.

¹ (More information is available at https://www.gov.uk/personal-tax-account.)

² Making Tax Digital – Bringing business tax into the digital age, HM Revenue and Customs accessed 15 August 2016)

³ ‘Making Tax Digital: Myth-Buster’, HM Revenue and Customs (accessed 12 July 2016)

Accountants help you keep an eye on major costs as early as the start-up stage, a time when you’re probably preoccupied with counting every paper clip and postage stamp. Accountants help you look at the big picture.

In fact, perhaps no other business relationship has such potential to pay off. Nowadays, accountants are more than just bean counters. A good accountant can be your company’s financial partner for life, with intimate knowledge of everything from how you’re going to finance your next forklift to how you’re going to finance your daughter’s university education.

A general accounting practice covers four basic areas of expertise:

1. Business advisory services
2. Accounting and record-keeping
3. Tax advice
4. Auditing

These four disciplines often overlap. For instance, if your accountant is helping you prepare the financial statements you need for a loan, and he or she gives you some insights into how certain estimates could be recalculated to get a more favourable review, the accountant is crossing the line from auditing into business advisory services.

The best way to find a good accountant is to get a referral from a business colleague, maybe even in the same industry. Don’t underestimate the importance of a FCA (chartered accountant). This title is only awarded to people who have passed a rigorous training and examination process.

The first step in setting the stage for a successful search is to take an inventory of what you will need. Given the level of fees you are prepared to pay, you must decide where your responsibility stops and where the accountant’s begins.

Once you have compiled your documentation and given some thought to your expectations, you’re ready to interview your referrals. Two or three candidates is a good number to start with. For each candidate, plan on two meetings before making your decision. One of these meetings should be at your site; one should be at theirs. Both parties need to know the environment the other works in.

During the ensuing interviews, your principal goal is to find out about three things:

Services
Most accounting firms offer tax and auditing services. But what about bookkeeping? Management consulting? Estate planning? Will the accountant help you design and implement financial information systems? Other services an FCA may offer include analysing transactions for loans and financing; preparing, auditing, reviewing and compiling financial statements; and representing you before tax authorities.

Although smaller accounting firms are generally a better bet for entrepreneurs, they may not offer all these services. Make sure the firm has what you need. In addition to services, make sure the firm has experience with small business and with your industry.

Personality
Is the accountant’s style compatible with yours? Be sure the people you are meeting with are the same ones who will be handling your business. At some accounting firms, partners handle sales and new business, then pass the actual account work on to other partners.

When evaluating competency and compatibility, ask candidates how they would handle situations relevant to you. For example: How would you handle an HMRC investigation seeking verification of vehicle expenses? Listen to the answers, and decide if that’s how you would like your affairs to be handled. Realise, too, that having an accountant who takes a different approach can be a good thing. Be sure that the accountant won’t pressure you into doing things you aren’t comfortable with. It’s your money, and you need to be able to sleep at night.

Fees
Ask about fees upfront. Most accounting firms charge by the hour; fees can range from £50 to £200 per hour. Quite often the fees depend on the service being provided. However, there are some accountants who offer a fixed fee spread with monthly payments. Figure out what services you are likely to need and which option will be more cost-effective for you. Get a range of quotes from different accountants.

Try to get an estimate of the total annual charges based on the services you have discussed. Don’t base your decision solely on cost, however; an accountant who charges more by the hour is likely to be more experienced and thus able to work faster than a novice who charges less. At the end of the interview, ask for references or testimonials, particularly from clients in the same industry as you.

After you have made your choice, ask for the terms of the agreement in an “engagement letter” that details the returns and statements to be prepared. This ensures you and your accountant have the same expectations and helps prevent misunderstandings and hard feelings. All professional accountants should be doing this as standard.

Make the most of the accounting relationship by doing your part. Don’t hand your accountant a shoebox full of receipts. The better you maintain your records, the less time your accountant has to spend, and the lower your fees will be. Ask your accountant if they provide accounting software, good accountants will have several cloud solutions available.

It’s a good idea to meet with your accountant periodically. Review financial statements and go over any problems so you know where your money is going. This is where your accountant should go beyond number-crunching to suggest alternative ways of cutting costs and act as a sounding board for any ideas or questions you have.

A good accountant can help your business in ways you never dreamed possible. Spending the time to find the right accountant, and taking advantage of the advice he or she has to offer, is one of the best things you can do to help your business soar.

Business plans aren’t just used for tempting investment; they should also drive your company in the right direction and provide a benchmark for ongoing evaluation. Here are some key points that a good business plan should include.

Many entrepreneurs fall into the trap of diving in before they have fully planned their new venture and then they wonder why it fails. If they had put the time into researching and writing a business plan, they would either have predicted the company wasn’t viable, or addressed the business model straight away.

AUTUMN STATEMENT 2013: MEASURES FOR A ‘RESPONSIBLE RECOVERY’

Delivering the Autumn Statement 2013, Chancellor George Osborne said the latest economic data showed that the ‘plan is working’. He said the biggest threat to securing the economy for the long term would be abandoning the plan, before setting out measures aimed at providing a ‘responsible recovery’.

In stark contrast to the March 2013 Budget, the Office for Budget Responsibility upgraded its forecast for growth in 2013. It expects GDP to grow by 1.4 per cent this year, more than double its March estimate of 0.6 per cent. It also expects an additional 400,000 new jobs to be created this year and for unemployment to fall to seven per cent in 2015.

Read our Autumn Statement 2013 report

FOR BUSINESSES
A two per cent cap on next year’s increase in business rates was confirmed. The doubling of the Small Business Rate Relief, to 100 per cent for qualifying businesses, was also extended by a year until April 2015. From 1 April 2014, businesses will be able to pay their rates over 12 months. And employer national insurance contributions for employees under the age of 21 will be abolished from April 2015.

Read our business announcements summary 

PERSONAL FINANCES
The planned fuel duty increase for September 2014 has been scrapped. Train fares will increase in January in line with RPI inflation only – not by the usual RPI plus one per cent. And basic rate taxpayers will be able to transfer GBP 1,000 of their personal allowance to a spouse or civil partner from 2015/16.

Read the personal finance measures overview

OTHER ANNOUNCMENTS
From September 2014, all schoolchildren in reception, year one and year two – as well as disadvantaged students in sixth form colleges – will be eligible for free school meals. And the paper tax disc will be replaced by a new digital system from October 2014.

Read a round-up of other headline announcements 

This infographic was produced by Sage

Mark Barrett, Accountant at Cannon Moorcroft and a Sage Business Expert,
offers his thoughts and predictions for next week’s budget. 

With the economy casting a gloomy shadow and the loss of the coveted AAA rating it’s unlikely we’ll see any big changes in the 2013 budget. The Chancellor has found himself on the points of a two pronged dilemma: trying to cut spending but encourage growth. As there’s little wiggle room within the budget due to constrained economic conditions, we shouldn’t expect to see any real cuts without corresponding increases to balance the books.

Anti-avoidance measures

I predict the main focus of this budget will be anti-avoidance measures for those who the government see as aggressive tax avoiders. It’ll be a delicate balancing act though as we trade in a global economy and the Chancellor will not want to discourage foreign investment.

Company-wise, the focus of the budget will probably be at the larger end of the scale. I predict a further reduction in Corporation Tax by 1%, bringing the large company tax rate in line with small company at 20%. The aim being to discourage avoiders transferring “management fees” to other companies within the group based in lower tax countries. Although the tax rate would be lower as a percentage, the tax paid should be higher as an amount.

The disappointing results of the 4G auction, (which fell £1.2 billion short of the sum estimated in the Chancellor’s Autumn Statement), will have left a hole that needs to be filled. With no impending sell-offs due, anti-avoidance measures are likely to be the salve for this wound.

Personal allowance

There is likely to be a further move towards the target of a £10k personal allowance starting in the 2014/15 tax year, although this may be held off until the 2013 autumn statement as a political ace to keep up his sleeve.

Fuel duty

Fuel duty may feature, although as each 3p cut in duty costs £1.6 billion, it may be that any increase is postponed for 6 months or reduced to a lower-than-inflation rate. Reductions in this area are important to small business as fuel costs can account for a disproportionately high amount of their spending.

National Insurance

The Conservatives have historically criticised increases in employers’ National Insurance Contributions as a tax on jobs, but have done little to tackle this. The cost to a business of employing staff is one of the most significant, so any reduction here will have a direct benefit on all companies, and could encourage jobs growth.

VAT rate

Growth could be achieved with a reduction of the current rate of VAT rate. If prices on the shelves were lowered by 2.5% to 5% a larger volume of goods would be sold, generating increased revenue which would mitigate against the reduced rate. This would also help towards lowering costs of those small businesses not VAT registered.

Annual Investment Allowance

With the Annual Investment Allowance already having been increased to £250k for two years in the Autumn Statement, it’s unlikely we’ll see movement on this. The Chancellor will probably wait to see if, over its two years, it has achieved its goals of increasing investment in plant and machinery to help support engineering and manufacturing. If it has worked, it will likely be announced in future budgets as there is no benefit to making changes now.

Green issues

With the government continuing to champion green issues, albeit mostly in word rather than in deed, it may use further investment allowances for companies investing in the research and/or production of green technologies to encourage development in what is widely seen as an important future growth area.

Employee Share Schemes

With the EU vote on banker’s bonuses going against the Chancellor, we may see further amendments to the taxation arrangements of employee share schemes to create a workaround to EU legislation. This already allows companies to pay out bonuses as shares, but we may see a more incentivised way of delivery that reduces the tax burden on the employees. It would be useful to see these schemes improved to benefit smaller PLCs, as it has been shown that when employees become shareholders it increases productivity. Just look at John Lewis’s figures last year, and the 17% bonus being paid out to its staff.

Real Time Information

Real Time Information (RTI) comes into effect in April, which should achieve savings within the tax credit system as the aim is to make changes more quickly based upon employees’ actual situation. We may hear about further consultation on how this model can be utilised further, particularly for sole traders who currently have a large grace period between tax incurred and tax paid, although the payments on account system is meant to iron this out.

A monthly RTI style system for small companies and non-incorporated traders, based on cash based accounts, looks highly likely to be approved (maybe even in this budget), so payments on account may become more frequent and more accurate. This would smooth out the cashflow from taxes that the government receives; so that instead of a large inflow of corporation tax in December and personal tax in January the inflow would be spread across the year. This would mean more administration for small businesses, which is unwelcome and generally viewed as unhelpful, but may help reduce the month to month borrowing needs of the government which are in some part a result of inconsistent cashflow.

Capital Gains Tax

Capital Gains Tax rarely features in budgets, with it being limited to slight annual increases or freezes. It may be that with Lib Dem pressure the current 28% top rate may be increased to 30% to 35%. This type of tax affects more top earners than middle earners typically, particularly with the sale of valuable assets such as second homes or works of art. An increase here could be seen as a Conservative answer to the Mansion Tax, and is certainly fairer than retrospectively taxing an asset currently held, especially as those assets are, usually, paid for out of taxed income. Any increase wouldn’t attract too much criticism either as it would affect relatively few tax payers, but would be seen as asking the rich to pay a bit more, which seems to be a constant argument from the opposition.

Little room for maneuver

In conclusion, we can’t expect to see too much change as there’s little room for maneuver. There will be a couple of headliners for the next day’s newspapers, but even they won’t be earth-shattering. Anti-avoidance is likely to be the biggest focus, especially as it will be popular with the media. Realistically, it is unlikely that the VAT rate will change, even though some are calling for an increase, but it may be that more types of purchases are brought under the VAT umbrella. Fuel Duty has been a popular area in previous budgets, so we can expect to hear something, even if it’s just a freeze. And finally it’s likely that green technologies will feature, particularly as the UK is struggling to meet its legally-binding commitments to renewable energy and carbon emissions.

Mark Barrett, Cannon Moorcroft

Find out what the Budget 2013 means for your business and sign up for Sage’s free Budget 2013 guide today.

Share your comments and hopes for the Budget in the comments below.

There is more to stock control than simply buying new products. You have to know what to buy, when to buy it and how much to buy. You also need to track your stock, whether manually or by computer, and use that knowledge to hone your purchasing process.

Maintaining Enough Stock
Your business’s basic stock should provide a reasonable assortment of products and should be big enough to cover the normal sales demands of your business. Since you won’t have actual sales and stocking figures from previous years to guide you during start-up, you must project your first year’s sales based on your business plan.

When calculating basic stock, you must also factor in lead time, the length of time between reordering and receiving a product. For instance, if your lead time is four weeks and a particular product line sells 10 units a week, then you must reorder before the basic Stock level falls below 40 units. If you do not reorder until you actually need the stock, you’ll have to wait four weeks without the product.

Insufficient stock means lost sales and costly, time-consuming back orders. Running out of raw materials or parts that are crucial to your production process means increased operating costs, too.

One way to protect yourself from such shortfalls is by building a safety margin into basic stock figures.

Avoiding Excess Stock
Avoiding excess stock is especially important for owners of companies seasonal product lines, such as clothing, home accessories, and holiday and gift items. No matter what your business, however, excess stock should be avoided.

It costs money in extra overhead, debt service on loans to purchase the excess stock, additional personal property tax on unsold stock and increased insurance costs. Buying excess stock also reduces your liquidity, something to be avoided.

When you find yourself with excess stock, your natural reaction will probably be to reduce the price and sell it quickly. Although this solves the overstocking problem, it also reduces your return on investment.

Some novice entrepreneurs react to excess stock by being overly cautious the next time they order stock. However, this puts you at risk of having a stock shortage. To avoid accumulating excess stock, set a realistic safety margin and order only what you’re sure you can sell.

Stock and Cash Flow
Cash-flow problems are some of the most common difficulties small businesses encounter, and they are usually the first signs of serious financial trouble ahead. Tying up money in stock can severely damage a small company’s cash flow.

To control stock effectively, prioritise your stock needs. It might seem at first glance that the most expensive items in your stock should receive the most attention. But in reality, less expensive items with higher turnover ratios have a greater effect on your business than more costly items.

Divide materials into groups A, B and C, depending on the monetary impact they have on the company (not their actual price). You can then stock more of the vital A items while keeping the B and C items at more manageable levels. This is known as the ABC approach.

Often, as much as 80 percent of a company’s revenues come from only 20 percent of the products. Companies that respect this “80-20 rule” concentrate their efforts on that key 20 percent of items.

Once you understand which items are most important, you’ll be able to balance needs with costs, carrying only as much as you need of a given item.

Tracking Stock
Good stock tracking systems will tell you what products are in stock, what’s on order, when it will arrive and what you’ve sold.

While manual methods may have their place, most entrepreneurs these days find that computerising gives them a far wider range of information with far less effort. You can even control stock right at the cash register with point-of-sale (POS) software systems. POS software records each sale when it happens, so your stock records are always up-to-date.

Features to consider in a POS system include the following:

· Ease of use. Look for software with a user-friendly graphical interface.

· Entry of sales information. Most systems allow you to enter stock codes either manually or automatically via a bar code scanner.

· Pricing. POS systems generally offer a variety of ways to keep track of pricing, including add-on amounts, percentage of cost, margin percentage and custom formulas. For example, if you provide volume discounts, you can set up multiple prices for each item.

· Updating product information. Once a sale is entered, these systems automatically update stock and accounts receivable records.

· Sales tracking options. Different businesses get paid in different ways. For example, repair or service shops often keep invoices open until the work is completed, so they need a system that allows them to put sales on hold.

· Security. In retail, it’s important to keep tight control over cash receipts to prevent theft. Most of these systems provide audit trails so you can trace any problems.

Every business is unique; you may find that none of the off-the-shelf systems meets your requirements. Industry-specific POS packages are available. In addition, some POS system manufacturers will tailor their software to your needs.

What legal status they should you opt for when starting up. Here are some of the legal options available to new companies.

When starting a business, one of the many important decisions you need to make is what legal status you should choose. Many people start out as a sole trader but there may come a time when you decide to register as a limited company, so it is important you know all the facts to ensure you make the right decision for you and your business.

Becoming a sole trader

A sole trader is a self-employed individual who runs their own business and is entitled to keep all business profits after tax has been paid on them.

There is no major issue in starting as a sole trader; you’ll find that it’s often cheaper to do it this way just to see if your business model works. It’s pointless spending money on incorporating a business, setting up business bank accounts, and filing accounts if the business is going to sit dormant.

If you decide to become a sole trader, you must register with HM Revenue & Customs (HMRC) as soon as possible after starting your business. It is important to register quickly because if you leave it later than 5 October in your business’ second tax year, you could be charged a penalty. So, for example, if you start up as a sole trader during the tax year 2012 to 2013, you must register before 5 October 2013.

As a sole trader, some of your tax responsibilities include filing a self-assessment tax return every year, paying income tax on your profits and paying national insurance.

Sole traders must also be aware of when to register for VAT. Once you hit the current VAT threshold of £77,000 turnover, you need to register for VAT. You do not (currently) need to become incorporated.

There is no distinction between business structures for VAT registration purposes, it’s the same for both sole traders and limited companies, currently you need to register if your turnover for the previous 12 months is more than £77,000. Note that it is not by financial or accounting year but actual previous 12 months.

Most businesses can register for VAT online, unless you are registering a business partnership, a business that is part of a group or division, or an international business, in which case you must register by post.

Some businesses may be interested in joining the Flat Rate Scheme. For firms with turnover of less than £150,000, who don’t buy a lot of products, then the flat rate scheme can work quite well. Using this you still collect 20% VAT from your customers but only pay a percentage of your gross sales to the HMRC, keeping the rest as additional profit for your company.

Official guidance states that, under the Flat Rate Scheme, you pay a fixed rate of VAT to HMRC, allowing you to keep the difference between what you charge your customers and what you pay over to HMRC. You can’t reclaim the VAT on your purchases, with an exception for certain capital assets over £2,000. To join the scheme, you must apply to HMRC.

Setting up a limited company

A limited company is legally separate from its shareholders or directors, meaning the company is liable for any debts.

Whilst sole traders are personally responsible for their business debts, the liability in a private company is usually limited to the shareholders.

I would consider starting as a sole trader, but nothing gives you more credibility than having a certificate of incorporation, or even being VAT registered. I have found over the years many customers prefer to see this. If you don’t have that, they won’t do business with you.

It is important to talk to an accountant when setting up as a limited company, and HMRC is a good place to go for advice on corporation tax.

If you do decide to set up a limited company, you must register it with Companies House and inform HMRC when the company starts business activities, an accountant can do all this for you.

Every financial year, the company is required to put together statutory accounts, send Companies House an annual return, and send HMRC a company tax return.

Just like a sole trader, a limited company must also register for VAT if turnover is likely to be over £77,000 a year.

Anyone or any business can be VAT registered, even if you don’t plan to hit the threshold, an accountant would be the best one to advise you on this one.

In terms of charging VAT, if you are below the VAT threshold, you can opt to register for VAT anyway, and then you should charge VAT. If you haven’t registered then you shouldn’t.

Most limited companies are private companies limited by shares. But there are also three other types: private companies limited by guarantee, private unlimited company, and public limited company.

For more information on incorporating a company, visit the Companies House website.

If you are starting a business that is social or environment, you could set up a social enterprise. If you decide to go down this route, you must choose a business structure. This can be either a limited company; charity; co-operative; industrial and provident society; or community interest company.

Each and every person setting up is different in circumstances and it’s at this point you need to chat to an accountant to make sure you are doing what is best for you. Think of the money spent talking to an accountant as a savings account, they are the ones who can advise you and make sure your legal status works for you.

Think again – A good accountant isn’t just a number cruncher, it’s someone who understands how to run a business in today’s economic climate, an experienced professional who will get to know you and your business and will provide you with essential support. Ultimately your accountant is someone you should regard as a trusted business advisor.

When you are starting out your accountant can help you evaluate your business idea, help you plan for a successful future and make sure you keep proper financial records.
Don’t underestimate how important your accounts are, they are a representation of your company so it’s crucial that you keep accurate records from the start, remember you may need to produce them for external parties such as HM Revenue & Customs and your bank.

Its not just bookkeeping, an accountant can help you in numerous areas of your business such as VAT, Corporation Tax, PAYE and Self Assessment. How much you use them is your choice and it doesn’t have to cost a fortune.

So, that just leaves whether or not you decide to use one?

Well, that should be an easy decision and to help you to make it, here are some of the benefits summed up for easy reference of using an accountant:

• Pay less tax
However good you are with numbers you’re not an expert: Take advantage of the skills of a qualified accountant, with their experience they may be able to find legitimate ways for you to pay less tax and save you money

• Improve profitability
An accountant will take care of your accounts, they can help you with budgeting and forecasting your cashflow, they will be able to offer advice on how to free up cashflow and where you can make savings. As your business grows they can advise you on how to manage the growth to help maximise your profits

• Save yourself time
Accounts can be time-consuming, using an accountant allows you to save time so that you can concentrate on what you do best: running your business

• Accurate accounts
Accurate financial information will help you analyse your business performance, it will enable you to assess what you have achieved as well as forecast and plan for the future. Plus looking to the future, accurate accounts will prove advantageous with your bank manager if you decide you need to raise capital for expansion

• Invaluable business advice
Whether you’ve just started or are now beginning to grow your business, an accountant has experience across a variety of industries and can offer you good quality professional advice and business solutions

• Reduce the risk of getting the figures wrong
Everyone has to pay tax, you can try and calculate it yourself but there are expensive penalties if you get it wrong: is it worth the risk? An accountant will be aware of all the relevant current legislation and will make sure that you comply with your legal requirements in the most efficient way.

The basic formula for break-even analysis, sometimes abbreviated as BEA, is as follows:

BEQ = FC / (P-VC)

Where BEQ = Break-even quantity

FC = Total fixed costs

P = Average price per unit, and

VC = Variable costs per unit.

Fixed costs are costs that never change no matter how much or little a company produces: administrative salaries, rent or mortgage payments, insurance, interest on borrowed funds, and similar costs sometimes also labelled fixed overheads. Variable costs are directly tied to product manufacturing or service provision: direct labour, raw materials, sales commissions, delivery expenses, etc.

In the formula shown above, BEQ, the “quantity,” refers to a single unit sold, whatever it might be. It may be a product like a teddy-bear (including its packaging) or something more complicated such a “carpet cleaning job” (including travel to and from the site). BEQ always refers to the actual item or service sold (teddy-bear or carpet cleaning job) rather than something that goes into it (e.g., teddy-bear stuffing or vacuum cleaner bags). BEQ is the entity the company puts a price on, “the unit.” Total sales of this unit, divided by the number of units sold, produces P, the average price. All costs associated with the unit, divided by number of units sold, yields VC, the cost per unit. Note that fixed cost is not included in VC.

Price per unit less variable cost per unit produces a surplus if the price is set correctly. In accounting terminology, this is called the “contribution margin.” It is the amount the sale of each unit contributes to the ultimate profitability of a company. When enough such chunks of contribution have been produced to equal fixed costs, the business has reached its break-even point. It isn’t profitable yet, but all of the overhead has been “absorbed.”

Supposing that fixed costs are £150,000. Price per unit is £85 and variable cost per unit is £75. The contribution margin will then be £10. Fixed cost divided by £10 results in 15,000. Therefore this company must sell 15,000 units just to break even. The next unit sold thereafter is the first contribution to profit. This company must sell 15,001 units to make a tiny profit of £10.

This example illustrates how changes can affect break-even. Fixed costs can be lowered, price can be increased, variable costs can be shaved. Conversely, if variable costs rise and cannot be lowered, contribution margin will sink and break-even will require more sales, unless for example, price is hiked or the company moves to cheaper space and lowers its rent substantially.

DIFFICULTIES AND APPLICABILITY

BEA is easiest to use in situations where the product or service is uniform and variable costs can be very clearly calculated and assigned to the “unit.” Significant analytical problems arise with complexity. In a medical practice, for example, the “unit” may be easy to determine: it is a single patient visit to the practice. But variable cost associated with every visit will vary with the patient’s condition, needs, medical insurance policies, the payments those policies cover depending on the diagnosis, the percentage of charges the patient must pay directly, and the variable costs of collecting that contribution. Administrative personnel dealing with insurance companies must maintain exacting records to tie their time not only to patients but to specific visits by each patient. Doctors, similarly, must be meticulous in dividing time between administrative duties (fixed costs) and patient-related activities (variable costs); these activities often extend beyond the visit itself, e.g., to time spent reviewing test results or studying recent literature on a disease or medication. Very substantial data must be gathered over a long time to arrive at precise data. Unless this is done, the break-even analysis will be too broad to serve informed management decisions.

Similar difficulties arise in many contracting businesses where the size and complexity of the contract, which is the “unit” and the great variability of inputs make it very difficult to produce a single number that means break-even.

Despite these difficulties, BEA is universally applicable. Attempts to apply it will bring out deficiencies in accounting and cost-tracking practices and will indirectly improve the management of the business.