Cash Flow Break Even Point
Break Even Point is a versatile metric for understanding when your business will become profitable and at what point you have enough revenue to cover all of your expenses. Break Even Point is essentially the minimum revenue or volume of sales needed to cover all operating expenses. Breaking even is neither a profit nor a loss, occurring when revenue equals expenses.
The break even point calculation can be adapted slightly to inform cash flow forecasts. Cash flow break even differs from standard break even calculations, as it determines when your cash expenses equal your cash revenue, while standard break even equates to a profit or a loss.
Understanding your business’ cash flow break even is also crucial for effective cash flow management, allowing you to make more informed decisions about your business’ finances.
Cash Flow Break Even Point Formula
The formula for calculating the standard break even point is:
Break Even Point (in units) = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit).
In this calculation fixed costs can include non-cash expenses such as inflation or depreciation. Variable cost per unit is simply the cost of producing one product, this is considered a variable cost as this can change as the volume of output changes due to economies of scale.
The cash flow break even point formula is:
Cash Break Even Point = Fixed Costs - Non-cash expenses / (Selling Price per Unit - Variable Cost per Unit)
This formula assumes that your only cash income is from sales revenue, but this can be easily adjusted to account for other types of cash revenue your business regularly receives. The main difference between the cash flow break even formula and the standard formula is the subtraction of non-cash expenses.
Here is an example of how an eCommerce business could apply the cash flow break even formula.
Say for example, your business sells shoes for £50 and it costs £25 to make each pair of shoes. Each month you have cash outgoings of £3,000 that cover the cost of your payment provider, licenses, shipping costs, packaging, business software and storage rental for stock. To calculate your cash break even point you would need to do the following calculation:
Break Even Point = 3,000 / (50-25)
If shoes are your only source of sales income and you have no non-cash expenses to account for that month, you would have to sell 120 pairs of shoes to cover all of your cash outgoings for that month.
Why is it important to have a cash flow forecast?
Break even analysis can be a valuable calculation for use when generating cash flow forecasts. Understanding the minimum amount of revenue you need to generate in order to pay bills, suppliers and employees on time is crucial to keeping your business afloat and can support more informed business decisions.
Having a cash flow forecast can help your business to predict and plan for periods of positive or negative cash flow in the future. Positive cash flow means you will have surplus cash left over after paying for all of your expenses. It is important to remember however, that positive cash flow does not equate to generating a profit. Ideally, businesses want to be experiencing positive cash flow, although this is not always possible or sustainable. For example, businesses should often be seeking opportunities to invest to grow their company and make processes more efficient. Reinvesting in the business can leave you short on cash in the short-term, causing a period of negative cash flow, but make your company more profitable in the long run.
Negative cash flow can become an issue if a business experiences it for long periods of time, leaving them unable to pay for operating expenses or grow their business. Understanding when these periods may occur by using a cash flow forecast can allow you time to prepare for these periods and understand why they are happening.
Using cash break even points in a cash flow forecast can also help to establish informed sales and revenue goals that ensure that operating costs are always covered.
Creating and monitoring your cash flow break even point is a simple addition to any cash flow forecast and supports effective cash flow management. Using cash break even point alongside traditional break even point calculations can also give business owners a more granular view of their minimum revenue requirements and support informed decision making.
Get started with cash flow forecasting and management with advice and guidance from our other eBook chapters.