Breakeven Analysis

When considering the long-term profitability of your venture, an investor will consider how long it will take for your business to break even. When a business takes more cash in sales than it spends in costs, it becomes cash positive and it is therefore less likely to need further capital investment. For this reason investors will want to know when your business will reach its ‘breakeven point’, both in a particular month and over the entire life of the business.

Profit and Loss Breakeven Analysis
Breakeven analysis allows you to calculate how many units you must sell to become cash positive in a certain month or year, given your:

• Unit price
• Variable costs
• Fixed costs
• Sales volume

Total Revenue = Unit price * Sales volume
Total Costs = Fixed costs + Variable costs

Your fixed costs are the costs you would pay in that month to run the business no matter how many units you sell: examples include rent and rates, audit fees. Your variable costs are the incremental cost of increasing output by another unit: examples include sales commission paid to third parties or raw material costs. This is assumed to be unchanging with respect to quantity sold.

Variable costs = Cost per unit * Sales volume

You breakeven when your total revenue = total costs.

In the example below:

• The fixed costs are £30,000
• The unit variable costs are £0.50
• The unit price is £1
• Break even is at 60,000 units

Cash Flow Breakeven
This provides a measure of how much cash must be invested in the business to take it through to profitability. In the example below:

• The fixed costs are £30,000 per month for the duration of the forecast.
• Sales increase from zero in month 13, after 12 months of development. There are some variable costs to consider.
• The monthly sales match the fixed and variable costs in month 19.
• Hence the business breaks even for that month and begins to bring in cash.
• n total around £250,000 has been invested over the first 19 months to reach this point. This is the total funding requirement.
• At 33 months as much cash has been recouped in total sales as was invested in the company. This is a cash flow breakeven point – marked BEP.

Practical Issues

• Although the costs and prices are only forecasts and may change, it is still possible to test the sensitivity of the breakeven point by using high, medium and low forecasts.
• In truth costs and prices do change with quantity, so it is important to forecast costs and prices for the approximate quantity you expect to sell in a certain year.
• Costs and prices can also fall with time, so the right forecasts for the right year must be used.
• The cash flow breakeven is distinct from the profit and loss breakeven. In the profit and loss, we consider a month or year for the company in isolation, and see how many sales are required to match costs. In the cash flow breakeven, we consider the next few years for the business and how much cash must be invested before the profit and loss breakeven. Sometime after this point comes the cash flow breakeven, when the business has recouped the investment made in it with total sales.