Break-Even

What is break-even?

Break-even (German Gewinnschwelle, also break-even point) refers to the point at which revenue exactly covers total costs, so that neither profit nor loss arises. It can be determined for a company, a product or a project. At this point, the sum of the contribution margins equals the fixed costs. The contribution margin is revenue minus the variable costs that arise with every unit sold; fixed costs such as rent and salaries are incurred regardless of volume. A food truck with a fixed pitch fee earns money only once the surplus from the portions sold has covered the fee. The number of portions at which that happens is its break-even.

Break-even analysis belongs to controlling and company planning. It appears in the business plan and in the financial model, in loan and grant applications, in funding rounds as a question about the path to profitability and in due diligence as a review of the cost structure. Besides the earnings-based break-even, practice distinguishes a break-even based on EBITDA (earnings before interest, taxes, depreciation and amortisation) and a cash flow break-even. They can be reached at different times.

Calculating break-even: formulas for quantity and revenue

Break-even quantity

The break-even quantity states how many units must be sold for the fixed costs to be covered.

Formula: Break-even quantity = fixed costs / contribution margin per unit

The contribution margin per unit is the price minus the variable costs. For subscription models, the number of paying customers in a month or year takes the place of the number of units.

Break-even revenue

Formula: Break-even revenue = fixed costs / contribution margin ratio

The contribution margin ratio is the share of the contribution margin in revenue. This form suits companies with many products or price tiers for which no uniform number of units can be stated. Both measures lead to the same point as long as prices and product mix remain constant.

Margin of safety and the effect above the threshold

The margin of safety measures by how much actual revenue exceeds break-even revenue, usually as a percentage of actual revenue. It shows what decline in revenue the company can absorb before it makes losses. Above break-even, not every additional euro of revenue becomes profit, but only its contribution margin: with a contribution margin ratio of 80%, EUR 100 of additional revenue increases profit by EUR 80. How strongly profit reacts in percentage terms to a change in revenue is described by operating leverage, the ratio of contribution margin to profit. It is greater the closer the company is to the break-even threshold, and it equals the reciprocal of the margin of safety.

Break-even over time

For growth companies, what counts is less the level of break-even than the point in time at which it is reached. In the financial model, this is the month in which the growing sum of contribution margins first reaches the fixed costs. Until then, the monthly losses add up to the capital requirement that the company has to finance up to break-even.

The timing shifts as soon as fixed costs do not remain constant. New positions in sales, development and customer support raise the fixed cost block in steps (step-fixed costs) and increase the required number of customers. Seasonal fluctuations also shift it. A company that is above the threshold in high-revenue months and below it in weak ones has reached break-even only when it holds over a full annual cycle.

Earnings, EBITDA and cash flow break-even

• Earnings break-even: The annual result after depreciation, interest and taxes is zero. It is the strictest accounting form, because it also includes depreciation on investments and the costs of financing.
• EBITDA break-even: Earnings before interest, taxes, depreciation and amortisation are zero. Growth companies usually reach it earlier and use it as the first proof that the operating business covers its running costs.
• Cash flow break-even: Inflows from the ongoing business cover outflows, depending on the definition including investments and repayments. From this point on, the company manages without new capital; the state is also called cash flow positive.

Which point is reached first depends on the business model. If customers pay annual fees in advance, liquidity flows in before the revenue is booked; the cash flow break-even can then come before the earnings break-even. Capitalised development costs, investments, inventories and long customer payment terms act in the opposite direction. A company can therefore report a profit in its accounts and lose liquidity at the same time.

Significance in financing, valuation and due diligence

Venture capital investors deliberately finance losses in order to enable growth. For them, break-even is therefore less a goal for the next months than a yardstick for the risk in the plan. The further in the future it lies and the more capital is needed until then, the higher the financing risk that flows into the valuation. A company that can reach break-even with the capital it has is considered default alive and negotiates from a stronger position.

In due diligence, the cost structure behind break-even is examined. This includes market-standard salaries for founders in the management, the delimitation of fixed and variable costs, the prices actually achieved and the positions that are added for the planned growth. A break-even that is reached only under assumptions that do not match the actual figures on any of these points is recalculated by investors and buyers.

Worked example: calculating break-even for a subscription model

A software provider has fixed costs of EUR 200,000 per month for personnel, rent and administration. A subscription costs EUR 250 per month; the variable costs per customer are EUR 50. Currently 700 customers pay, and a net 25 are added every month.

• Contribution margin per customer: EUR 250 minus EUR 50 = EUR 200, contribution margin ratio 200 / 250 = 80%
• Break-even quantity: EUR 200,000 / EUR 200 = 1,000 paying customers
• Break-even revenue: EUR 200,000 / 0.80 = EUR 250,000 per month, that is, EUR 3.0 million per year
• Time to break-even: (1,000 minus 700) / 25 = 12 months
• Monthly loss in the first month: EUR 200,000 minus 725 × EUR 200 = EUR 55,000; it falls every month by 25 × EUR 200 = EUR 5,000
• Cumulative loss up to break-even: sum of the monthly losses from EUR 55,000 in the first month to EUR 5,000 in the eleventh month = EUR 330,000
• Additional positions from month 7 with EUR 20,000 of fixed costs per month: new break-even quantity 220,000 / 200 = 1,100 customers, reached after (1,100 minus 700) / 25 = 16 months
• Cumulative loss in this case: EUR 255,000 in months 1 to 6 plus EUR 225,000 in months 7 to 15 = EUR 480,000
• In the base case at 1,200 customers: profit (1,200 minus 1,000) × EUR 200 = EUR 40,000 per month on EUR 300,000 of revenue; margin of safety (300,000 minus 250,000) / 300,000 = 16.7%
• Operating leverage at 1,200 customers: EUR 240,000 contribution margin / EUR 40,000 profit = 6, that is, the reciprocal of 16.7%
• Revenue decline of 10% to 1,080 customers: profit 1,080 × EUR 200 minus EUR 200,000 = EUR 16,000, that is, 60% less

The example shows four relationships. Above the threshold, profit grows only by the contribution margin: 200 additional customers bring EUR 50,000 of additional revenue but only EUR 40,000 of profit. Just above the threshold, profit reacts strongly: a revenue decline of 10% costs 60% of profit. Additional fixed costs shift break-even by four months and raise the capital requirement until then by EUR 150,000. If the management's remuneration were below market level, the reported break-even would be reached earlier than under third-party conditions.

Distinction: break-even, cash flow positive and burn rate

• Cash flow positive: describes the state in which the company permanently generates more liquidity than it consumes. The cash flow break-even is the point in time at which this state begins.
• CAC payback period: the break-even of a single customer, that is, the point in time from which its contribution margin has recouped the acquisition costs. It concerns the unit, not the company as a whole.
• Burn rate: the monthly consumption of liquidity before the cash flow break-even is reached. Burn rate and available liquidity give the runway.

Common mistakes

• Fixed costs assumed constant. Growth requires additional positions and infrastructure. Without these steps, the plan shows a break-even that moves further back as growth proceeds.
• Founders' salaries below market level. A break-even that is reached only because the management forgoes market-standard remuneration does not withstand due diligence.
• Contribution margin ratio taken from the price list. Discounts, payment defaults and the effort of customer support lower the actual ratio. What matters are the actual values of the last twelve months.
• Earnings and liquidity equated. A reported profit does not protect against liquidity bottlenecks if funds are tied up in receivables, inventories or investments.
• Individual months as proof. A break-even in a seasonally strong month is not yet a sustainable break-even.

Frequently asked questions

How is the break-even point calculated?

By dividing the fixed costs by the contribution margin per unit; the result is the break-even quantity. For break-even revenue, the fixed costs are divided by the contribution margin ratio. With EUR 200,000 of fixed costs per month and EUR 200 of contribution margin per customer, the threshold is at 1,000 customers.

Must a growth company reach break-even before a funding round?

No. Venture capital finances precisely the phase before break-even. Investors do, however, expect a traceable path to it and a statement of the revenue and cost structure at which the threshold would be reached if growth were slowed.

How are break-even and runway related?

The runway states how long the available liquidity lasts at the current rate of consumption; the cash flow break-even marks the point in time from which no further consumption arises. If break-even lies within the runway, the company does not depend on new capital. If it lies beyond, the financing must reach at least a milestone that supports a follow-on round.

What role does break-even play in a conversation with the bank?

A necessary but not a sufficient one. Banks examine debt service capacity: beyond the running costs, the cash flow must also carry interest and repayments on the loans. A company exactly at break-even therefore cannot yet service a loan from its own resources.

The Roemer Capital view

In the financial model, we show the timing of break-even in all three planning cases, in each case separately for EBITDA and cash flow. We plan the fixed costs in the steps in which positions and infrastructure are actually added, and the management with market-standard remuneration. This way the threshold also withstands an investor's calculation in due diligence.

In preparing a funding round, we link this calculation with the runway, which should be 12 to 18 months when the process starts. If the model shows that the cash flow break-even would be reachable within this span with slowed growth, that is an argument that carries equally in conversations with investors and banks.