One would think that making money in modular construction would be easy considering the number of new houses needed just to keep up with demand. You would also think that going modular is the smart thing to do.
You’re probably right on both assumptions but along the way, something went wrong that is forcing you to decide if you can actually keep your factory open.
In my post today, I will discuss a factory’s breakeven point and why factory owners really don’t know their breakeven point or in some cases, simply ignore it.
Break Even Point
Determining the breakeven point for a modular factory involves understanding both the fixed and variable costs of production, as well as the revenue generated from selling each module. The breakeven point is where total revenue equals total costs, resulting in neither profit nor loss.
Here’s a step-by-step approach to determine the number of modules a factory must build and sell in a month to breakeven:
Determine Fixed Costs
These are the costs that don’t change regardless of the number of modules produced. Examples include rent or mortgage payments for the factory, salaried employees’ wages, insurance, property taxes, and general administrative expenses.
Determine Variable Costs Per Module
These costs vary directly with the number of modules produced. Examples include raw materials, labor (if paid per module produced or hours worked), utilities directly associated with production, and any other costs that increase with each additional module made.
Determine the Selling Price Per Module
This is the amount for which you can sell each module to your customers.
Let’s use a simple example:
Fixed Costs: $500,000 per month
Variable Costs Per Module: $70,000
Selling Price Per Module: $88,500
Contribution \ Margin \ Per \ Module = $84,500 – $70,000 = $14,500
Breakeven \ Point (in \ modules) = $500,000 / $14,500 = 34 modules per month
In this example, the factory would need to produce and sell roughly 34 modules in a month to break even.
It’s essential to remember that this calculation provides a simplification. In the real world, there might be other factors, fluctuations in costs or prices, or economies of scale that can affect the breakeven point. Regular reviews and updates to the calculation are advised as these factors change.
Most factory owners don’t know their breakeven point?
While understanding the breakeven point is fundamental to business management, it’s not uncommon for some factory owners and upper management to be unaware of their exact breakeven point. Several reasons can explain this:
Complexity of Costsignornace is
Some factories have a broad range of products, each with its own set of variable costs. Calculating a precise breakeven point for such factories can be intricate and time-consuming. Factories building custom homes and one-off projects fall into this category.
Changing Variables
The variables involved in determining the breakeven point, like material costs, labor rates, and overhead, can frequently change. Keeping up with these changes can be challenging, especially if they’re not regularly tracked. The modular industry is a cyclical business but just knowing that is no excuse for not staying on top of your numbers.
Focus on Cash Flow
Some modular factory owners are more concerned about cash flow than profits, especially in industries with long production cycles or where significant upfront investments are required. In such cases, the emphasis might be on ensuring that enough cash is coming in to cover immediate expenses rather than calculating a precise breakeven point. Major projects where modules are waiting in the yard to be delivered cost a factory a lot of money that is quite hard to calculate, so many owners simply don’t bother.
Lack of Financial Acumen
Not all business owners have a strong background in finance. An owner with a background in the operational or technical side might not be as familiar with financial metrics. Many owners assume their General Manager is looking “at the books” when in fact, nobody is.
Over-Reliance on Financial Teams
Some owners might rely heavily on their financial team or external accountants to monitor the company’s finances. This can lead to a scenario where the owner is disconnected from these essential metrics. Most financial people brought in to take care of the books have little or no idea what modular production entails and tend to equate modular with the benchmark they are using on every business they’ve worked.
Use of Alternative Metrics
You gotta love those owners that prioritize other metrics over the breakeven point. For example, they might focus on return on investment, profit margins, or other financial indicators. Breakeven…not their major concern.
Lack of Regular Review
Even if the breakeven point was calculated at some point, it might not be reviewed regularly. Without periodic reassessments, the relevance of the initial calculation can diminish. If I were to ask 100 modular factory owners the last time they calculated their break-even numbers, I wonder what they would say? Some business owners might not understand the significance of knowing the breakeven point, viewing it as a theoretical concept rather than a practical tool.
For effective business management, it’s beneficial for modular factory owners to understand their breakeven point, as it provides clarity on the company’s financial standing and helps in making informed decisions.
My Personal Experience with Poor Accounting
Five decades ago my family ran a chain of convenience stores. When we first got started, my father had a very simple accounting system. All the invoices for the week went in the big “lard” can on the left side of his desk and every Sunday night he would dump them on the desk and pay them. Then he would throw them in the can on the right side of the desk. Very simple and as it turned out, very dangerous.
If you are still using a simple “Lard Can” style accounting system, here are some reasons to put it away and become organized.
Expense Creep – Without you even knowing it’s happening, small expenses start adding up into a giant vacuum that sucks the lifeblood out of your business. Cash Flow is the blood that keeps your business alive.
Overdue Accounts – If you miss a payment to a bank because you forgot to make it, that can start a snowball effect with the bank. If you forget to invoice a customer for a draw, that will help kill the cash flow. You should never be too busy to request draws when they are due or pay your bills.
Expense abuse – Because cash flow is essential to your survival, it is super important that you track your expenses. If you just pay them and forget them until the end of the year, one or more of them may be out of sync with your projections if you even have projections.
Data Security – I mentioned the lard cans above. One night my father, a cigar smoker, dropped it into the unpaid lard can. It burnt all the invoices, insurance payments, employee timecards, etc. It took weeks to get the mess straightened away. We hired our first bookkeeper the next week. Make sure your records are secure.
Bankruptcy – With the majority of businesses failing in the first 5 years, poor financial management remains one of the top reasons for failure. It is your responsibility as a small business owner to maintain and regularly assess your financials. Not putting an accounting system in place early during your startup can mean the end of the business. Proper accounting can help you see money-losing strategies before it is too late.
Meeting your creditors and lenders – Do you really think being able to dump the contents of a show box or large folder on the desk of a lender will impress them or will it make you look as disorganized as you really are? And do you think a creditor cares when you tell them you can’t find their invoice? No! They just want to be paid.
In my travels around this industry, I’ve actually run into several “lard can” accounting systems.
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Gary Fleisher, the Modcoach, author
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