Breakeven Point: Why It’s Not Actually a Point
When building a high-potential company, a magic inflection for entrepreneurs is the breakeven point. Why? That is when the business has become self-sustaining, no longer dependent on outside cash infusions to keep going. Yet, practically, it isn’t really a point at all!
A common investor question is when your business will hit breakeven. That makes breakeven point sound like a single magical moment in time, but it isn’t. Because there are so many dynamic factors that go into achieving that critical threshold, it is possible – even likely – that your business may bump along in the zone of breakeven for a while before getting really established as a cash-generating instead of cash-using business. Yet this threshold does provide some indication of when the business becomes self-sustaining.
Two Types of Breakeven
Let’s start by defining “break-even point.” There are two variations:
Cash flow breakeven is the point where a business’s incoming cash exactly covers its outgoing cash. This is a crucial measure of immediate financial sustainability. It’s assessed based on what volume of sales less variable costs gives you the cash required (contribution margin) needed to cover your fixed cash costs (e.g., costs that don’t vary with sales volume, such as rent, salaries, insurance, etc.). In other words, what’s the minimum sales needed to keep the business afloat from a cash perspective?
Accounting breakeven is the point at which a business becomes profitable, including non-cash expenses such as depreciation and amortization. This is when you’re covering all operational costs, including those accounting accruals, and is an indicator of long-term performance and profitability.
Why Breakeven Isn’t Really a Point
So, let’s take a few moments to reflect on some entrepreneurial lessons about the breakeven point.
Regardless of which version you are considering, for all practical purposes, breakeven is not a single point. Accounting textbooks and the output of internet searches will happily give you some nice formulas for how to calculate breakeven points like those defined above. They will define the breakeven point as the level of sales at which cash inflows equal cash outflows, or net income equals zero. However, from a business management perspective, this is misleading because it misses all the complexity of how you build a business to that level. So, while these formulas are useful for understanding what these terms mean, they cannot answer the investor’s question about when you will achieve breakeven.
The challenge is that when you are building a high-potential business, you are trying to launch your product and grow your revenue, which requires growing investment in your marketing and sales capabilities. Simultaneously, you are building up your operational capacity to deliver your products and services successfully at hopefully growing sales volume levels. This means a lot of interdependent moving parts!
Some businesses could be cashflow breakeven at $100,000 in sales revenue per year while others might not achieve cashflow breakeven until they have a few million dollars in sales. In fact, it is quite plausible that a bootstrapped business could be inching along at a very low level of sales, using last month’s contribution to fund the following month, yet unable to grow without an infusion of outside capital. Such a business could be cashflow breakeven at a very low level (and likely paying only a pittance to the founder), yet realistically, a much higher sales volume will require a substantial investment to build up capacity and grow sales to be substantially cashflow positive and generating wealth for the team and investors on a continuing basis.
You Need a Full Financial Forecast Model
This dynamic means that really assessing and planning how to build your business requires a full-fledged financial forecast model that tracks all a business’s revenue and expenses on a monthly basis, with roll-ups into quarters and annual summaries. Such a model needs to forecast your essential monthly financial statements (income statement, balance sheet, and statement of cash flows) based on a full set of interlocking assumptions about what your business needs to look like over time as you achieve rapidly growing sales. A well-developed model will help you determine at what level of sales the business will actually achieve a continuing cash flow breakeven (major milestone!). Your model will also help you plan what funds you need to raise to achieve key milestones along with helping to define the big bucket use of proceeds for those fundraising forays.
It is imperative to develop plans and forecasts that show financial results over time and growth, so you can see when you achieve the mix of sales volume, gross margin, and expenses that consistently puts more cash in than you spend. When you are able to do that over a sustained period of months, then you can realistically say you have “achieved cashflow breakeven,” and can have the option to decide whether it is worth it to take on further investment to power another big growth spurt or whether you should fund your growth with internally generated cash.
The High-Growth Paradox
One characteristic of high-potential businesses is rapid growth. That means the business leaders are not dealing with a static situation but are instead building capacity quickly and selling like crazy to achieve that growth. Often, that means that you are hiring and marketing and building out ahead of achieving the next level of revenue, which effectively pushes out when you will be able to be self-sustaining.
Such rapid growth is also risky because if any of your assumptions are substantially off, then you can find yourself needing to use your cash reserves to fund operations for a while you learn and get the flywheel going at the level you were planning for. This illustrates why it is dangerous to think of cash flow breakeven as a point in time. Just hitting it by a few bucks in one month will not matter if you cannot continue to generate more cash than you are using and have enough to expand on a continuing basis.
This is why looking ahead and figuring out how to build capability, resilience, and cushion into your plans is essential to absorb some of the unknowns that will likely bite you along the journey. A bit of a cash war chest can last quite a while when you get close to covering your expenses as you seek to expand your margins and increase your sales volume to achieve self-sufficiency.
Why Investors Care About Breakeven
Investors care about breakeven because they don’t want to invest in businesses that do not have a business model that can ever achieve self-sufficiency. They may be happy to be part of seeding the development of a high-potential business, but they do not want to invest in a business that can never be self-sustaining, so they ask about breakeven to ensure that the business leaders have a plan for building the business to that level—and the timeline for getting there is reasonable.
By the way, most of the time, investors are referring to cash flow breakeven when they ask, ‘When will you reach breakeven?’ If they are thinking of accounting breakeven, they will usually ask about profitability. The difference between these two can be quite significant for businesses that have invested a great deal in capitalized product development expenses, which then translate into significant accounting accruals requiring substantial additional sales growth to cover, while cashflow breakeven can often mean the business does not require continuing influxes of investor cash to keep going.
The Bottom Line
Understanding breakeven—really understanding it—means grasping that it’s not a destination but a zone you navigate through. It requires robust financial modeling, realistic growth planning, and a sufficient cushion to handle the inevitable surprises. When you can articulate this nuanced understanding to investors, you demonstrate the kind of sophisticated business thinking that gives them confidence in your ability to build a sustainable, high-potential company.
