Break-Even Point

Break-Even point is an essential concept for evaluating the feasibility of startups and businesses. It is often required by investors or institutions assessing businesses and startups prior to supporting or investing in them₁.

Normally, the business loses money at first as it invests in its capital and kicks off operations, and it is normally the case for successful businesses to cope with that loss overtime as their income grows and their costs decline. Once their income equals their costs, one can say that the business is at break-even, meaning that it is not losing money any more, and is likely to generate profits given that other constraints don’t change.

To calculate the Break-Even point, three variables are needed:

1. Fixed costs
2. Variable costs
3. Selling price of a product

*Contribution Margin=Price - Variable Costs. The contribution margin calculates the margin by which the price can cover fixed costs

Break-Even Point Example 1:

Let’s say Golden Frames is a company that produces wooden frames for photos, and has the following variables:

• Its overall fixed costs are $30,000
• Its variable cost per frame is $2
• Its price per frame is $5

Thus, the following applies:

The result of the above will be 10,000 units. Meaning that Golden Frames has to sell 10,000 frames to break-even

Break-Even Point Example 2:

Fresh Bakery produces pies, and has the following monthly costs

From the above table, Fresh Bakery must have a price of at least 0.5 for every pie to cover the variable expenses.
If we suggest the price per pie is $2, this means we have $1.5 contribution margin ($2 for the pie- 0.5 for variable costs for each pie).

So Fresh Bakery needs to sell 3,133 pies a month to cover its costs.

Break-Even Analysis and the Margin of Safety

Understanding the break-even point and break-even analysis helps identify the margin of safety for a business or a product line. This margin of safety is a concern for investors and was initially founded in the stock market to mean the amount of tolerable losses that one (or a business) can bear without having a significant negative impact on finances or the business. Thus, the safety margin identifies the sales needed to pay for the cost of doing business (including fixed and flexible costs).
 
In addition to the safety margin, break-even analysis can help identify the following:

• Estimated earnings and losses at a given point in time.
• The minimum sales level acceptable to you avoid incurring losses.
• If discarding a certain product line can improve profits.
• If price changing (higher or lower prices) affects profitability.
• If cost changing (higher or lower costs) affects profitability.
• Ultimately if a planned product/service will be profitable and exceed break-even.

What is a good Break-Even Point for Startups? How Long Should I Wait Before Making Profits?

Aside from the theory, let's get real. Startups are often found to create income and generate revenue for their owners. But that cannot happen from day one, which is why we should calculate the break-even point. In this article: "Can selling less improve the bottom line?" we discuss the importance of taking it step by step and prioritizing growing first before focusing on profits. But how long is long enough?
 
In today's connected world and the opportunities provided by online channels, revenue streams are plenty and there is no real measure or average that applies to all cases. Some startups take a few months, while others require years. What you can do, however, is to consider making revenues where you can, even if this revenue doesn't turn into profit quickly. working on a long-term strategy of improving revenues and keeping costs down can shorten the time needed to break even and turn to profit.