All companies have the goal of being profitable, but before they can get there, the first step is to break even. Once a company is able to reach a point where they aren’t losing money, they can then ideally scale up and experience exponential growth. There are many ways to run break even analysis, the most common being in Excel. To get fancy, you can refer to a break even analysis template. But if it’s simple, you can use a break even analysis calculator.
A break even analysis helps consultants understand the relationship between revenue, costs, and profits at a company that’s just getting started. It can also be helpful to identify the volume of sales it will take to achieve success with a new internal venture – launching a new product, division, or geography. Break even analysis is one of the most simple forms of financial analysis, and also happens early in the decision-making timeline – after all, if you won’t at least make your investment back on a particular venture, why move forward with any other part of the planning process?
Because these are common analyses for consultants, you will get break even analysis questions in case interviews. Many times, you will be presented with a scenario in which your client is working on a new product or considering purchasing a business. This is a cue for you to consider using break even analysis to see the quantity needed to be produced to make the venture a profitable one. The more likely it is to hit and go beyond those quantities, the stronger the opportunity.
What is Break Even Analysis?
As the name suggests, break even analysis helps determine the point when a company breaks even – or earns as much as it spends. In other words, it is the point when a company’s revenue equals its costs. Ultimately, you are trying to find the quantity of a product or service that needs to be sold in order to break even.
The three core components of a break even analysis include:
- Fixed Costs
- Variable Costs per Unit (Average)
- Price per Unit (Average)
Break even analysis solves for volume of units that need to be sold.
B.E.A. – Fixed Costs
Fixed costs are costs that increase in a step function (i.e. they don’t change based on the number of units produced). For instance, regardless of whether a car factory manufactures 1 car or 100 cars in a month, it will still need to pay the same amount of rent if it is leasing the factory space. That rent is a fixed cost.
Some common fixed costs include:
- Property taxes
Depreciation is a non-cash expense that is usually not utilized when consultants are conducting break even analysis.
Break Even Analysis – Average Variable Costs per Unit
Variable costs are costs that do change based on the number of units produced. If you had a lemonade stand, your costs for lemons, cups, and other materials would change depending on how many cups of lemonade you are able to sell. These raw materials are examples of variable costs.
Some common variable costs include:
- Raw materials
- Sales commissions
- Direct labor costs
- Production supplies
B.E.A. – Average Price per Unit
Pricing can be one of the trickiest pieces of data to incorporate in a break even analysis because unlike costs, prices are more freely determined by a business and and the market at large. Companies often look at what competitors are charging for similar products or base their prices on how much it costs to produce each item.
Note: pricing has nuances that are important to consider. For example, all prices should be net of discounts.
The Break Even Formula
The break even analysis formula is simple:
Break even point = Fixed Costs / (Price per unit – Variable Cost per unit)
This break even analysis formula will provide you with the number of units of product or services you need to sell to break even.
Let’s next see the break even analysis in action!
Break Even Analysis Example
Let’s assume that you’re working on a case interview and your client is a well known t-shirt manufacturer. The client is considering producing sweaters as well but wants to figure out if this is a potentially profitable idea. As you work through the case, you are able to extract the following pieces of data:
- Fixed costs will be $100,000 per month
- Average variable costs per sweater will be $20
- Average price per sweater will be $70
Using the break even analysis formula, let’s figure out how many sweaters you’ll need to sell each month to break even:
Break even point = $100,000 / ($70 – $20) = 2,000 units
Thus, in order for your client to break even, it will need to sell 2,000 sweaters per month. If it seems possible that your client can sell more than that per month, it should go for the venture. If not, it would be better for your client to focus on using its resources elsewhere.
Pretty simple right? Of course, in real life, the situation is much more complicated and there are many more moving parts. However, the fundamental idea is the same.
Break Even Calculators and Templates
There are some resources online that help you calculate your break even analysis and they are linked below. If you would rather start from scratch and calculate the entire analysis yourself, you can of course always do break even analysis in Excel as well. See the break even analysis calculators below:
Break even analysis is a useful – and necessary – tool to help assess profitability. Familiarize yourself with the break even analysis and excel in your consulting roles!