Break-Even Analysis

By Entrepreneur Staff

Pencil

Break-Even Analysis Definition:

A technique for analyzing how revenue, expenses and profit vary with changes in sales volume

One useful tool in tracking your business's cash flow is a break-even analysis. It's a fairly simple calculation and can prove very helpful in deciding whether to make an equipment purchase or in knowing how close you are to your break-even level. Here are the variables needed to compute a break-even sales analysis:

  • Gross profit margin
  • Operating expenses (less depreciation)
  • Annual debt service (total monthly debt payments for the year)

Since we're dealing with cash flow, and depreciation is a noncash expense, it's subtracted from the operating expenses. The break-even calculation for sales is:

(Operating Expenses + Annual Debt Service)/Gross Profit Margin = Break-Even Sales

Let's use ABC Clothing as an example and compute this company's break-even sales for years one and two. In Year 1, the company's sales were $1 million and their gross profit was $250,000, resulting in a gross profit margin of 25 percent ($250,000/$1 million). In Year 2, sales were $1.5 million and gross profits were $450,000, resulting in a gross profit margin of 30 percent (($450,000/$1.5 million). Now let's use calculate their break-even sales figure:

Break-Even Sales for Year 1:
(Operating Expenses of $170,000 + Annual Debt Service of $30,000)/
Gross Profit Margin of 25 percent (.25) = $800,000 break-even sales figure

Break-Even Sales for Year 2:
(Operating Expenses of $245,000 + Annual Debt Service of $30,000)/
Gross Profit Margin of 30 percent (.30) = $916,667 break-even sales figure

It's apparent from these calculations that ABC Clothing was well ahead of break-even sales both in Year 1 ($1 million sales) and Year 2 ($1.5 million sales).

Break-even analysis also can be used to calculate break-even sales needed for the other variables in the equation. Let's say the owner of ABC Clothing was confident he or she could generate sales of $750,000, and the company's operating expenses are $170,000 with $30,000 in annual current maturities of long-term debt. The break-even gross margin needed would be calculated as follows:

($170,000 + $30,000)/$750,000 = 26.7%

Now let's use ABC Clothing to determine the break-even operating expenses. If we know the gross margin is 25 percent, the sales are $750,000 and the current maturities of long-term debt are $30,000, we can calculate the break-even operating expenses as follows:

(.25 x $750,000) - $30,000 = $157,500

More from Financial Management

Cash Float Accounts

A bank account specifically set up by a business owner to float money through from Business A to enhance the perceived value of Business B

See full definition

Cost-Benefit Analysis

A process by which you weigh expected costs against expected benefits to determine the best (or most profitable) course of action

See full definition

Assets

The value of any tangible property and property rights owned by a company less any reserves set aside for depreciation. Assets don't reflect any appreciation in value unless they're sold for the greater value.

See full definition

Debt-to-Equity Ratio

A measure of the extent to which a firm's capital is provided by owners or lenders, calculated by dividing debt by equity. Also, a measure of a company's ability to repay its obligations. If ratios are increasing--more debt in relation to equity--the company is being financed by creditors rather than by internal positive cash flow which may be a dangerous trend.

See full definition

Latest Articles

Science & Technology

5 Rule-Bending AI Hacks to Make Your Mornings More Productive and Profitable

By 2025, AI will transform productivity by streamlining workflows and cutting costs. Major companies like Microsoft, Google, and OpenAI are leading the way, advancing AI into "Phase 3," where tools act as digital assistants. Discover 5 AI hacks to boost efficiency and redefine your daily routine.

Side Hustle

'Hustling Every Day': These Friends Started a Side Hustle With $2,500 Each — It 'Snowballed' to Over $500,000 and Became a Multimillion-Dollar Brand

Paris Emily Nicholson and Saskia Teje Jenkins had a 2020 brainstorm session that led to a lucrative business.