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Nathan Bush: one of those calculations that tends to live on the to do list. The business is always moving fast. There's always something more immediate to do and it just keeps on getting pushed. It's not something that just gets ignored on purpose. It just doesn't feel as urgent as the campaign that needs approving or the stock order that needs a decision. But it is so important to know your break even number. The problem is that without it, the revenue target that you're working towards doesn't really have a foundation. You don't know if that number is right. You don't know if a smaller number, a smaller break even number would actually give you the same outcome. And you can't know whether hitting it makes the business healthier or just busier. Matt Byrne runs Day One Advisory. It's an accounting and bookkeeping firm that works specifically with Shopify brands using Xero. He's the outsourced finance function for e commerce businesses all across Australia. And his argument is is that most businesses are chasing revenue targets that have no maths behind them because no one has calculated the number that gives the revenue target its job. That's the break even target that we'll be talking about today. Let's hear first from Matt.
Matt Byrne: We tend to work direct with founders and we work with them from you know where effectively they're outsourced finance function for their e Comm business.
Nathan Bush: Okay. And you mentioned Xero. There is Xero the only financial software platform that you use.
Matt Byrne: It's the only one we use. Yep. I mean the other one is QuickBooks that you'll hear about. And certainly in the US it gets a bit more traction than it does in Aus. As an accountant there's some functionality that's missing. So we find that Xero is the the better option. And to be honest, 95% of businesses in Australia are operating on Xero already anyway, so we rarely come across anything else.
Nathan Bush: Yeah, okay. One of the things around Xero that we often hear is being able to reconcile on an order by order basis for E commerce. It's not as easy as when you're doing B2B.
Matt Byrne: Affiliation yeah, it's horrible. I would never recommend it unless you fancy spending all of your time sitting in front of your computer doing bookkeeping. It is a horrific way to do your books. And there are much easier ways to deal with things. And there's wonderful bits of software like A2X for example, that will go and get that Shopify data and it'll bundle it up nicely and it'll just park it in Xero in, you know, a few payouts each day and it will make everyone's life a lot easier.
Nathan Bush: Beautiful. Good tip there. Straight out of the gates with a brilliant tip for anyone who's reconciling order by order still. Now tell me, when you go in and talk to a new E commerce client for the first time, and like you said, you're probably speaking to a founder, what are the three numbers that your eyes go to straight away to try and understand where this e commerce business is at, whether it's a healthy business?
Matt Byrne: Yep. The starting point is always gross profit. I mean, very rarely will we look at revenue in isolation. It's a, tends to be a useless metric most of the time. So we are always looking at gross profit. So do the products that they sell have enough margin in them so that they can advertise them and sell them to the customers and then there's enough leftover that it's going to cover their, their overheads?
Nathan Bush: What does a good gross profit look like to you?
Matt Byrne: Oh, I mean it depends on the business. Right. Like I've got a client who sells digital products. Their gross profit is enormous. They have no product costs, no delivery costs, et cetera. Right. So their gross profits like must be 90% plus. If you've got a standard sort of typical e commerce business that sells and delivers products, I would say a good one is in the sort of at least 50% mark, our client base that sort of does really well. And the ones that have a lot of margin available that ultimately leads to profit and net cash, they tend to be doing around the 60, 65% mark mark, which is pretty good.
Nathan Bush: And do you find most businesses have that margin from the outset or do they build towards it? Like we hear a lot around people who are looking to buy an E commerce business or launch a new E commerce business, do you find that they go out with the margin predetermined or do you have to work your way towards that? 50, 55, 60, 65%?
Matt Byrne: No, I think gross profit margin should generally work from the beginning.
Nathan Bush: From day one.
Matt Byrne: Unit economics have to work. Yes. You're going to get some benefits of scale. So as you start ordering bigger volumes, your supp will give you some volume discounts and you might, you know, your proportionately your freight costs are going to be less. But ultimately I think that is a few percentage points. It's not 20% or 30%. So if you're going into business with a 20% margin or 80% product cost and you're thinking that there's some magic bullet that at 5 million of revenue that's going to end up being, you know, dropping by half, I think that's probably a little bit too optimistic. And I think unit economics should work from the very first day you start selling. And if they get better, awesome. But if they don't, well, you're still
Nathan Bush: okay, you've still got a business.
Matt Byrne: Yeah, absolutely.
Nathan Bush: All right, so number one, metric, gross profit.
Matt Byrne: Number two, contribution margin, which is basically gross profit minus your direct ad spend.
Nathan Bush: Yeah.
Matt Byrne: So really we're looking at, well, you can call it a few different things, contribution margin. You can express it as MER or blended roas or whatever you want to look at it as. But basically are you selling costs low enough that they're going to leave some margin left over? Right. I've actually seen quite a few businesses where they have a reasonably healthy gross profit margin, but they spend so much money on acquiring the customer that actually it's all gone.
Nathan Bush: Yeah.
Matt Byrne: And so the number that really matters is your contribution margin because that is how much is left after you've done everything that you possibly need to do to deliver that to the customer. And the reason, I mean, I actually don't know if this is a real thing or not, but I say that contribution margin is how much is it contributing to paying your overheads and your profit.
Nathan Bush: Yeah.
Matt Byrne: Okay, so that's the way I look at contribution margin. It's how much is it actually contributing to the business? Everything above that, it's not really your money, it's just the cost of getting that product out. So gross profit margin is important, but you have to then have some leftover after you've acquired your customer.
Nathan Bush: Okay.
Matt Byrne: I would argue contribution margin is more important than gross profit, but they're sort of all interconnected a little bit, but
[Ad]: I suppose you've got a little bit
Nathan Bush: more to play with with contribution margin. You can pull it back and you've got a few more levers in there, don't you? Rather than gross profit, is your gross profit. There's probably not much if you in there to change your, your product range.
Matt Byrne: Yeah, I suppose you can go down some different ways of selling your product that maybe don't cost as much, et cetera. But yeah, you're right. But ultimately you've still got to have the contribution margin available in order to use it to cover the cost of your business and pay yourself some money.
Nathan Bush: And when you are working with businesses, roughly what percentage of revenue would you say is healthy to be spending on marketing and advertising?
Matt Byrne: Again, it ranges, I think. I don't know. I tend to see businesses like less than 30, 35%. I think as soon as you start going above that, you're really going to start to struggle. But again, it depends entirely on what your unit economics look like. So going back to my example before, if you've got a customer who sells a digital product with no deployment costs, well, they can afford to have a roas of two times because they don't have other costs to deploy so they can sell that. If you've got a product where you've only got a 50% margin, well, you are going to struggle if you spend 45% of your revenue on ad spend. Right. So if your business is healthy and it's doing, I don't know, 65% and then you go and spend 25% on marketing, I think that is probably a pretty healthy number. I'm no marketing guy though, right? That's definitely not my department.
Nathan Bush: You're the guy who comes in and slaps the marketing team around when they're spending too much.
Matt Byrne: I think that you need to have clear expectations of what your budget is on your marketing so then you can keep people to account. Right. So they don't go and go crazy with the spending.
Nathan Bush: There's a big line of thought around E commerce at the moment, around scaling marketing when it's working. So doubling down on campaigns or ads, especially in Meta, that are working especially to acquire new customers. How do you feel about that from an accounting perspective when you talk about that? It's like having a really clear view on how much you're spending and the contribution margin. If you've got a team that's like actually if this campaign's working really well, just keep going until you're stopping, seeing that return how do you manage that?
Matt Byrne: Well, again, that's not usually my department, but I've had this conversation, I think at least four times this year already, where my advice has been to spend more money. And that's not usually the advice that comes from accountants, and certainly a lot of accountants who don't deal with E Commerce. I was having a conversation with a client the other day, and the conversation from their existing accountant or their previous accountant was, you actually need to spend less money on ads. Like, you're spending too much money on ads. And it's like, well, that's great in another business, but it's driving the sales and it's driving the contribution margin. And this was a business that had good margins, like, it could afford to do it. So my view is kind of, well, if. If it's working and it's within your margins to do that, then yeah, keep going. Because for every dollar that you spend, as long as you've got the product to fulfill it and the customers that are gonna keep buying it, well, go for it. In real dollar terms, it's profit. Happy days.
Nathan Bush: Great. Okay, so we've got gross profit, we've got contribution margin. What's your third metric that you're really keeping an eye on?
Matt Byrne: Break even. So the break even point is effectively, how much product do I need to sell at my contribution margin in order to cover all of the overhead cost of the business? And this is one that I think doesn't get looked at very often. And I think it's a really good metric to track because what it does is it gives you context in terms of what revenue is a good target for you. I mean, you'll hear everyone jumps online and every guru will talk about what their sales are. They'll spin up their Shopify dashboard and it's like, well, Fantastic. I've done $5 million of sales over the last five years, or what have you, and you go, that's great. But it's meaningless. Like, revenue is a meaningless number. It doesn't help anybody. It's a vanity.
Nathan Bush: It's great on LinkedIn, it looks great
Matt Byrne: on LinkedIn, but it doesn't provide anything in terms of free cash flow or profit or anything like that. So having your overhead cost and understanding your break even in terms of sales dollars and product volume and that sort of thing then gives you purpose. Like, why are you trying to sell a million dollars of product if you can actually make the profit you need to at 600? You know, so it's context. And I think that it's A helpful I think every business owner should know their break even and then you should be obviously trying to sell enough product to cover those costs and make some profit.
Nathan Bush: And those overhead costs are predominantly team members, stock, warehousing, physical premises, anything else, not even stock.
Matt Byrne: So stock's always going to be above the line, right in terms of your growth profit. But yeah, it's going to be your general subscription costs. Wages, rent, those tend to be the big ones for E Com businesses.
Nathan Bush: What Matt is walking through here is a sequence where each number builds on the last number and the one at the end of that sequence. Breakeven is the one that tells you what the revenue target should actually be. So here's how to use it. Lesson 1 Start with the sequence, not the target before you can calculate a meaningful breakeven, you need two numbers in place first. First, gross profit. Secondly, contribution margin. Breakeven is built on top of them and if either is off, the break even will be too. Gross profit is revenue minus the cost of making and delivering your product. For a typical E commerce business, selling physical goods, Matt says that 50% is a reasonable floor. His better performing clients are closer to 60 and 65.
[Ad]: Below 50%, it's really hard going.
Nathan Bush: The model is already under pressure before advertising, weigh wages or overheads come into play. Now, contribution margin is gross profit minus direct ad spend.
[Ad]: This is what's actually left after you've
Nathan Bush: acquired the customer and delivered the product. A business can have a healthy gross margin and still be in serious trouble if acquisition costs are through the roof. And Matt sees that regularly businesses spending so heavily on ads that the contribution margin is close to zero, which means overheads are coming out of nothing. What makes this dangerous is that revenue can look completely healthy while both of these numbers are broken underneath it. Anita Sarkar built Hero Packaging into one of Australia's most recognisable and different sustainable packaging brands. They have awards, strong sales and by every visible measure things were going really well. Then she brought in an external cfo, a Taylor Zolder's time, and found out that the business was so cash poor that they might need to go into voluntary administration. Revenue had been looking great. Gross profit and contribution they were not. So even the smartest operators need to stop and do a practical check of what both those numbers look like at a product level, not just aggregated across the business. Because a blended gross margin across the whole range can look fine, but individual products can be dragging it down. Get into the product level first and don't just rely on that overall number if you want to break even that you can trust number two. The formula takes 10 minutes. Run it twice. Here's the calculation. Take total monthly overheads and then divide by your contribution margin percentage. I'll say that again. Take the total monthly overheads and divide by the contribution margin percentage. That is your revenue break even. It's the sales figure that the business needs to reach before it even makes $0.01 of profit. Then divide that by the average selling price and you get the unit break even. So how many products are actually needed to be sold to cover the machine that you're operating? Matt's worked example, $50,000 a month in overheads, 30% contribution margin. Now divide 50,000 by 0.3. That means you need about $167,000 in revenue just to stand still. Not a million, not 5 million, not 100,000. You need $167,000 to break even. That's the flaw. Now this formula, it's been around a long time. It's not unique to E Commerce, but it still catches people out the first time that they run it. Jason Andrew from SBO Financial was teaching it back in episode five of Add to Cart episode five and he said that almost always a sobering experience for the founders that he worked with. Not because the maths is complicated, but because most of them had actually just never done it. They'd never sat down with him and just run what's the break even number here? So run at once with the numbers as they are today. Then this is how you level up. Run it again with two things that are often left out. The first is subscriptions. Shopify Klaviyo Fulfillment Software reporting tools. Matt mentioned that $5,000 a month in subscriptions is not unusual for a mid size E commerce business. And it's a line that needs to be undercounted. When people pull together their overall total, make sure it's in there properly. The second is the full cost of the people running the business. Not just the obvious headcount, but the roles that sometimes get treated as investment rather than overhead. So think about senior hires, including their bonuses, agency retainers, contractors sitting outside of the normal cost lines. Matt's point is that the overhead figure needs to reflect the real cost of operating the business. Without that, the break even often looks a lot lower than it is. We are often very conservative here. And a break even that flatters you is the kind of thing that actually makes the problem bigger than not knowing it. The second version of the calculation with subscriptions and full people costs included is the real one. That's the number worth knowing and is the one worth bringing into strategy conversations. We would rather have a higher break even than an imaginary lower 1. Lesson 3 Use break even before you make a decision, not after. Once you have that break even number the amount of money that you need to make in order to cover your costs of running your business, the most useful thing you can do is apply it before major trading decisions rather than using it to explain a margin report that just doesn't look right afterwards. Discounting is the clearest example here. When you discount contribution margin per unit drops, that means that the number of units needed to break even on the promotion goes up, sometimes really severely. Before approving a sale campaign, the question worth asking is at this discount level, what is the new contribution margin per unit and how many units do we need to sell just to break even on this? That's not even to profit, just to break even. That number should be in the brief before the campaign runs known by the whole team, and it shouldn't be a question that comes in post results Jason Andrew described doing exactly this after Black Friday, working out for each client whether the discounting campaign had actually been worth it by calculating how many extra units they needed to sell just to cover the margin that they gave away on price. Most of the time the number is higher than anyone is expecting it to be. The same logic applies to ad spend. If the business is targeting a four times or a five times return on spend, that target should come from the contribution margin and the break even, not from whatever your platform dashboard says is a healthy number. The margin dictates exactly what return is needed. Everything else is a benchmark someone else has invented for a different business or is a vanity metric that the industry will just talk about. It also applies to stock decisions. Tom and Natalie Hinser from Mr. Poolman learnt this the hard way. The business was growing, orders were coming in and then they had to stop operations for six weeks because they were slowly going down broke. The sales were there, but their margin discipline, it wasn't there yet. When they rebuilt the business they put a monthly tracking process in place with contribution and break even as the anchor for every stock and every trading decision. Natalie's line about this was that everyone talks about revenue, but it's actually the last figure that you should look at when operating your business. The habit worth building is running a quick break even sense check before any significant commercial decision. It doesn't need to be a full model. Once you've done it a few times, you'll know what a good break even looks like and it'll be ingrained in what you do every day. Overheads Divided by Contribution Margin Then a stress test on what happens if the margin shifts. If the numbers still work, make the move. Go for gold. If they don't, you've caught something well before it costs you.
[Ad]: What I love about this is that
Nathan Bush: the formula isn't actually complicated. Overheads including subscriptions and the full cost of all the people in your business divided by contribution margin percentage that gives you your revenue break even. Divide that by the average selling price and you have the unit floor. Those two numbers are what give a revenue target an actual job rather than just being a number on a whiteboard. If you want to work through what a real break even calculation looks like for your business, or maybe maybe even compare notes with other operators on their breakevens or how they think about contribution margin, those conversations are happening right now in the Add to Cart community. You can join for free over@addtocart.com that's the playbook for this week. I'll see you next Friday.
