Break-even point

Below it you lose money, above it you make money. The break-even point is where a venture starts to pay.

The break-even point is the level of output or sales at which total revenue exactly equals total cost, so the firm makes neither profit nor loss. Below it the venture loses money; above it, it profits. It is one of the first numbers any business should know.

How it is found

Break-even is found by comparing the contribution each unit makes toward fixed costs with the fixed costs themselves. Each unit sold earns its price and incurs its variable cost; the difference, the contribution margin, goes toward covering fixed costs. Divide total fixed costs by the contribution per unit and you get the number of units that must be sold to cover everything. Sell more and the contribution becomes profit; sell fewer and fixed costs are not fully covered.

What it reveals about risk

The break-even point is really a statement about risk and cost structure. A business with high fixed costs and high contribution per unit has a high break-even point, far to climb before it profits, but earns strongly once past it. A business with low fixed costs breaks even early and is safer in a downturn but may have thinner margins. Comparing the break-even point to realistic expected sales shows how much cushion a venture has.

Uses and limits

Break-even analysis is invaluable for pricing, for deciding whether a product is worth launching, and for judging how far sales can fall before a business is in trouble. Its limits come from its simplifying assumptions: that costs split cleanly into fixed and variable, that price is constant, and that the world holds still. Real costs and prices vary with volume and time, so break-even is a guide and a sanity check rather than a precise prediction.

The break-even point answers a question every venture must face before any other: how much must we sell merely to not lose money? Until that number is known and judged against what sales are plausible, talk of profit is premature.