If you are a business owner or manager, you probably want to know how much sales revenue you need to cover your expenses and start making a profit. This is where the concept of break-even analysis comes in handy.

Break-even analysis is a method of determining the level of sales at which your business neither makes a loss nor a profit. It is the point where your total revenue equals your total costs. Knowing your break-even point can help you plan your budget, set your prices, and evaluate your performance.

However, there are different types of break-even points, depending on what costs and revenues you include in your calculation. One of the most useful types is the cash break-even point, which focuses on the cash flow of your business.

What is the Cash Break-Even Point?

The cash break-even point is the level of sales at which your cash inflows from sales equal your cash outflows for fixed and variable costs. Unlike the traditional break-even point, the cash break-even point does not include non-cash expenses, such as depreciation and amortization, in your costs.

The reason for excluding non-cash expenses is that they do not affect your cash flow. They are accounting entries that reduce your net income, but they do not require any cash payment. Therefore, they do not affect your ability to pay your bills and meet your obligations.

The cash break-even point is especially important for businesses that have high levels of fixed assets, such as machinery, equipment, or buildings. These assets usually have significant depreciation charges, which can make your net income look lower than your actual cash flow. By using the cash break-even point, you can get a more realistic picture of your cash situation and your profitability potential.

How to Calculate the Cash Break-Even Point?

The formula for calculating the cash break-even point is:

Cash Break-Even Point = Fixed Costs – Depreciation / Contribution Margin per Unit

where:

• Fixed Costs are the costs that do not change with the level of sales, such as rent, salaries, insurance, etc.
• Depreciation is the non-cash expense that represents the loss of value of your fixed assets over time.
• Contribution Margin per Unit is the difference between the selling price and the variable cost of each unit of your product or service. Variable costs are the costs that change with the level of sales, such as materials, labor, commissions, etc.

To use this formula, you need to know your fixed costs, depreciation, selling price, and variable costs. You can find these information from your income statement, cash flow statement, or accounting records. Alternatively, you can use the following steps to estimate them:

1. Identify your fixed costs. These are the costs that you have to pay regardless of how much you sell, such as rent, salaries, insurance, utilities, etc. Add up all your fixed costs for a given period, such as a month or a year.
2. Identify your depreciation. This is the non-cash expense that represents the loss of value of your fixed assets over time. You can use the straight-line method to calculate your depreciation, which is:

Depreciation = (Cost of Asset – Salvage Value) / Useful Life

where:

• Cost of Asset is the original purchase price of your asset.
• Salvage Value is the estimated resale value of your asset at the end of its useful life.
• Useful Life is the number of years that you expect to use your asset.

For example, if you bought a machine for $100,000, and you expect to sell it for $10,000 after 10 years of use, your depreciation would be:

Depreciation = ($100,000 – $10,000) / 10 = $9,000 per year

3. Identify your selling price. This is the amount of money that you charge for each unit of your product or service. You can use your current or projected price, depending on your purpose.
4. Identify your variable costs. These are the costs that change with the level of sales, such as materials, labor, commissions, etc. You can calculate your variable cost per unit by dividing your total variable costs by the number of units sold in a given period, such as a month or a year.
5. Calculate your contribution margin per unit. This is the difference between your selling price and your variable cost per unit. It represents the amount of money that each unit of your product or service contributes to covering your fixed costs and generating a profit. The formula is:

Contribution Margin per Unit = Selling Price – Variable Cost per Unit

6. Plug in the numbers into the cash break-even point formula and solve for the number of units. This is the level of sales at which your cash inflows from sales equal your cash outflows for fixed and variable costs. The formula is:

Cash Break-Even Point = Fixed Costs – Depreciation / Contribution Margin per Unit

For example, suppose your fixed costs are $50,000 per year, your depreciation is $9,000 per year, your selling price is $20 per unit, and your variable cost per unit is $10. Your cash break-even point would be:

Cash Break-Even Point = ($50,000 – $9,000) / ($20 – $10) = 4,100 units

This means that you need to sell 4,100 units of your product or service per year to break even in terms of cash flow.

How to Interpret the Cash Break-Even Point?

The cash break-even point is a useful indicator of your business performance and potential. Here are some ways to interpret and use the cash break-even point:

• Compare it with your actual or expected sales. If your sales are higher than your cash break-even point, you are generating positive cash flow and profit. If your sales are lower than your cash break-even point, you are losing money and cash. You can use this information to evaluate your current situation and plan your future actions.
• Compare it with your traditional break-even point. The traditional break-even point is the level of sales at which your total revenue equals your total costs, including depreciation. If your cash break-even point is lower than your traditional break-even point, it means that your depreciation is a significant part of your costs, and that you have more cash flow than net income. If your cash break-even point is higher than your traditional break-even point, it means that your depreciation is a small part of your costs, and that you have less cash flow than net income. You can use this information to assess your profitability and liquidity.
• Use it to set your sales goals and prices. You can use your cash break-even point as a minimum target for your sales, and as a reference for your pricing strategy. You can also use it to calculate the margin of safety, which is the difference between your actual or expected sales and your cash break-even point, expressed as a percentage of your sales. The margin of safety measures how much your sales can drop before you start losing money and cash. The higher the margin of safety, the lower the risk of your business.

Conclusion

The cash break-even point is a valuable tool for analyzing and managing your business. It helps you understand how much sales revenue you need to cover your expenses and start making a profit, based on your cash flow. It also helps you compare your cash flow and net income, and set your sales goals and prices. By using the cash break-even point, you can improve your decision-making and optimize your business performance.