Cash Flow Break-Even Point
For early-stage companies, one important question arises pretty soon in the business growth journey:
When will we become profitable?
While it’s impossible to answer this question with crystal ball accuracy (if only), we can use financial calculations and forecasts to help us understand at what sales volume we’ll become profitable.
The particular metric we want to keep our eye on here is called the cash flow break-even point.
It may sound a little complex, but it basically tells you at what point your business will be bringing in enough cash to service your financial obligation. In short, at what point you’ll “break even” and then start making a profit.
This article is your guide to cash flow break-even point.
What Is Cash Flow Break-Even Point?
Your cash flow break-even point is the point where your operating cash inflows match your operating cash outflows.
Side note: Operating cash flow = cash inflows and outflows related to the primary thing your business does. If you sell marketing services, then revenue from marketing clients, and expenses related to those projects, are included here. Cash flow from financing and investing activities are not.
That is, the cash you’re bringing in from normal daily operations is consistently equal to or higher than the expenses required to keep your company running at that level.
For example, if your monthly expenses are $20,000 and you’re bringing in $15,000 in revenue, you’re not quite at the break-even point.
Once you get to $20,000 in revenue, you’ll reach cash flow break-even.
That is, of course, assuming your expenses don’t increase on your way there. That’s commonly the case, however—you’ve got to spend money to make money.
That’s where understanding how to calculate your cash flow break-even point becomes important.
How To Calculate Cash Flow Break-Even Point
The formula for calculating your cash flow break-even point (in units) is as follows:
Cash Flow Break-Even Point = Fixed costs / (Revenue per unit – Variable costs per unit)
So, to calculate your cash flow break-even point, you’ll need three fundamental pieces of information:
- Fixed costs
- Variable costs per unit
- Revenue per unit
When we say “per unit,” we mean this broadly. It might be per item if you sell a physical product, per user if you’re selling software, or per hour if you’re selling a consulting service.
The point is that you need to be able to quantify how much your expenses increase each time you make a sale, known as your variable costs.
Let’s explore why.
Imagine you’re a lean business offering sales prospecting services, and you have fixed costs of $250,000 a year. Those fixed costs are your rent for the head office, loan repayments, and insurance.
This means that whatever happens, whether you make money or not, you’ve got $250,000 to pay.
So, if you make $250,000 in revenue, you’re covered. Right?
To make that $250,000, you’ve got to take on a number of additional variable costs:
- Contracted sales reps
- Phone expenses
- New sales CRM users
Imagine that all of that cost an extra $100,000. You made $250,000 in revenue, but your expenses increased to $350,000, so you haven’t yet broken even.
That’s because we missed the variable part of the equation.
We need to know:
- How much it costs to make each sale (variable cost per unit)
- How much revenue we earn per sale (revenue per unit)
Let’s say that your $250,000 in revenue came from 20 sales. This means your average revenue per sale is $12,500 ($250,000 / 20), and your variable cost per unit is $5,000 ($250,000 / 20).
Now, we have all the figures we need to calculate our cash flow break-even point:
- Fixed costs: $250,000
- Variable costs per unit: $5,000
- Revenue per sale: $12,500
Remember, here’s what our formula looks like:
Fixed costs / (Revenue per unit – Variable costs per unit)
So, plugging in our figures from above:
$250,000 / ($12,500 – $5,000) = 33.333 units
This means that we need to close 33.33 sales in order to break even. At an average revenue of $12,500 per deal, this equates to $416,625.
We can check this figure (and understand why it works) by doing a bit of back engineering,
If we close 33.33 sales, we make $416,625 in revenue. But remember that each sale costs us $5,000 in variable costs, equaling $166,625. Add that to our $250,000 in fixed costs, and we get $416,625.
As such, our total costs equal our revenue, meaning we broke even.
Why Should You Track Cash Flow Break-Even Point?
Considering that your cash flow break-even point takes more than a couple of minutes to calculate, it is worth asking the question:
Why even bother looking at it?
Here are four reasons why you should calculate cash flow break-even.
To Better Understand Profitability
The first one is, maybe, a little obvious, but it’s the most important.
Calculating your cash flow break-even point helps you determine exactly when you’ll turn a non-profitable business into a profitable one.
Say, for instance, that you calculated your break-even point to be 2,400 units per month. You’re currently selling 1,400 units a month, and that’s been increasing steadily at 100 additional units per month.
With this information, you’re able to determine that, with current growth trends prevailing, you’ll become profitable in another 10 months.
To Set More Realistic Goals And Growth Plans
Once you have a strong idea of what it will take to break even and become profitable, you can start building goals and plans for future growth that are grounded in hard figures.
Let’s say, for example, that you recently opened up a baked goods store.
You’d like to take your brand nationwide, but you need to focus on turning a profit first.
With your break-even point calculated, you can set a timeframe for becoming profitable, and then set your sights on a funding round to take place after this event, providing you with capital to put into new locations.
Speaking of investors…
To Seek Out Funding
If you’re looking to engage in some form of funding, be that debt financing from a bank loan or equity financing from an angel investor or venture capitalist, you’re going to be asked about future profitability.
Investors and lenders will want to know at what point you’ll become profitable, so having your cash flow break-even point calculated in advance is going to put you in their favor.
To Make More Informed Pricing Decisions
Your cash flow break-even point is deeply tied to what you charge for your product or services.
With that in mind, small adjustments to pricing can actually have a huge impact on your ability to turn a profit.
In some cases, adjusting pricing upward by just a few dollars can dramatically decrease the number of units you need to sell to hit break-even, turning an impossibility into a viable business model.
Track Cash Flow Break-Even Point In Finmark
Understanding cash flow break-even point—what it means for your business as well as how to calculate it—is clearly important.
You’ll want to calculate your break-even point early as you’re first conceptualizing your business model.
However, you should also consider the fact that, like it or not, things change.
Expenses increase, your ability to charge a given value for your product or service shifts with the market, and if you’re doing everything well, sales and marketing can become more cost-effective, driving down customer acquisition costs.
All of this means that your cash flow break-even point is unlikely to remain stable over time.
As such, rather than thinking of this as a one-time, set-and-forget equation, you should instead be monitoring cash flow break-even point on a consistent basis.
Let us save you a bit of time in the process and introduce you to Finmark from BILL.
Finmark is the financial planning and forecasting platform for startups and SMBs.
In our intuitive and user-friendly platform, you can set up a formula to calculate and even forecast your cash flow break-even point, using your actual expenses and revenue to deliver accurate figures as data points change.
This content is presented “as is,” and is not intended to provide tax, legal or financial advice. Please consult your advisor with any questions.