Break-even analysis is a calculation, based on a set of assumptions, to determine the amount of revenue required for a venture or project to at least cover all its operating costs. At the point of break-even (required revenue) the venture or project is neither making money nor losing it. The profit = $0.
Break-even analysis is an important metric that is used when making investment decisions. It quantifies the assumptions that underpin the investment decision and exposes them to the due diligence of experienced minds. If experienced minds believe the assumptions that calculated the break-even to be conservative and easily achievable, then the investment in the venture or project is likely to proceed. If they believe the assumptions to be a 'stretch' and difficult to achieve then the investment in the venture or project is unlikely to proceed.
Before calculating the breakeven an analysis needs to be done to determine the value of the fixed costs, variable costs % and the Gross Profit %. This is typically done by analysing past financial statements.
  • Fixed costs are those costs that don't change in relation to sales volume or business activity (i.e. rent)
  • Variable costs are those costs that do change in relation to sales volume or business activity (i.e. packaging)
  • Gross Profit is the value that remains after deducting the direct costs (typically Cost of Goods Sold) from the revenue. Dividing this amount by the revenue calculates the Gross Profit %.
These metrics, produced by the analysis, allows you to make informed assumptions about the venture or project that you are undertaking. Applying these assumptions to the following formula calculates the break-even value.
Break-even can be expressed in a few ways:
  • Revenue $ - i.e. $10,000 per month
  • Units - i.e. 500 units per week
  • Time target - i.e. 'We plan to breakeven in 6 months time"
In starting a new business, there are different types of break-even calculations you will need to do:
  1. Financial Break Even: The revenue point at which the new business covers all its financial commitments to external parties but which is not yet paying the owners a wage for their work or a return on their investment.
  2. Sustainable Break Even: The revenue point at which the new business is meeting its financial commitments to external parties and paying the owners what it would cost to replace them with staff and providing the owners with a competitive rate of return on their investment.
  3. Equity Break Even: The amount of revenue required to repay from profits the equity invested by the owners in the business.
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