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Reaching and surpassing the break-even point, which signifies the level of revenue needed for a company to become profitable, holds critical significance for entrepreneurs. This threshold is defined by fixed costs and margins on variable costs. To succeed, it’s vital to decrease fixed costs, increase margins, and strike a balance in technical and marketing investments to foster sustainable growth.
E. Krieger
For an entrepreneur, reaching and surpassing the break-even point often marks the end of the first tunnel. This break-even point is indeed the level of revenue needed for a company to become profitable. It is determined by the fixed costs of your business and the margin on variable costs (break-even point = fixed costs / margin on variable costs). If profitability is measured by your Earnings Before Interest and Taxes (EBITDA), then your break-even point becomes the minimum level of sales required for EBITDA to be equal to zero.
This definition shows that the break-even point can be achieved and exceeded in two ways: by reducing fixed costs and/or by selling with as high a margin as possible.
However, this observation becomes more complex for certain companies. While many activities are immediately profitable with few fixed expenses (personnel costs, rent, marketing and sales investments), others require substantial costs and investments and may generate revenue and, consequently, profit margins only after several years. This can delay reaching the famous break-even point. This is often the case for technological startups, whose medium-term value can be a multiple of EBITDA or even a huge multiple of the company’s revenue.
Certain activities require few fixed expenses and generate comfortable margins on variable costs right from the start, exceeding 40% or even 50%. This is particularly true for service-based businesses. Nevertheless, their growth potential might be more limited compared to other enterprises with higher fixed costs, but whose profit margins will be more comfortable due to a highly differentiated offer covering a global market.
Numerous companies in sectors like cosmetics, pharmaceuticals, or spirits have direct margin percentages well above 60%. These companies, when in full operation, comfortably exceed their break-even point and serve as authentic cash flow generators.
Optimizing the level of fixed costs
Determining the level of fixed costs is important. If you use external contractors, their cost will clearly vary but is generally higher than if your company hired similar profiles as employees (fixed costs). For instance, a freelance programmer might cost around $500 excluding taxes per day, while a similar profile earning $2,500 net/month would cost around $250 per day, including social charges – half the cost of the outsourced programmer.
If you have sufficient visibility on your order book, it’s beneficial to hire such an IT specialist. However, this would create annual fixed costs of around $50,000. This example illustrates that while significantly improving your margin on variable costs, you’re simultaneously increasing your fixed costs. This could be problematic if your order book were to significantly and durably decrease, such as during an economic downturn.
Hiring more employees significantly raises your break-even point, but it also has a positive impact on the quality of your offering, especially in terms of responsiveness and after-sales service. It also enables you to harness talent to develop your business. Fixed costs are often an unavoidable step for entrepreneurs seeking growth.
What about pricing and marketing budget?
Calculating your break-even point can be done for a specific activity or even a single product. In such cases, isolate the fixed expenses specific to that activity or offer. The previous dilemma regarding hiring (fixed costs) or outsourcing (variable costs) is then enriched with equally essential questions: at what price can you sell? Are our prices higher than those of the most dangerous competitor?
By reducing our selling prices (and thus our margins), can we significantly increase sales volumes? What marketing and sales investments are required to promote our offering and achieve our business goals?
The selling price directly impacts your break-even point, as the margin on variable costs depends on the price level, and the price also influences your sales volumes.
Returning to fixed costs, it’s essential to remember that even the most competitive products and services don’t sell themselves. Therefore, it’s necessary not to skimp on your marketing budget, which in turn increases your break-even point. But what would be the point of having a theoretically very low break-even point if sales weren’t there and the business ultimately ran at a deficit? While a marketing plan certainly has a cost, it’s also the best way to maximize your chances of exceeding your business objectives.
Break-even point and business plan
What if your revenue dropped by 30% due to a market downturn or intense competition? Would your business remain profitable, or would you need to cut fixed costs and/or modify your offering to improve margins? When creating a business plan, it’s precisely these types of questions that need to be considered and modeled, with various assumptions regarding selling prices and fixed costs.
This illustrates that analyzing the break-even point raises fundamental questions about our business model and our strategic and financial goals. While it’s important to quickly surpass the break-even point, it’s not always advisable to lower it at the expense of the overall quality of the offering and customer satisfaction. Ultimately, it’s all about finding the right balance…
