Break-Even Point

The break-even point is where an activity stops losing money and starts making it. Below the break-even point, costs exceed revenue or savings; above it, the activity is profitable. For a product, it is the number of units that must be sold to cover fixed and variable costs. For a technology investment, it might be the number of users, transactions or months needed before savings cover the cost.

Break-even analysis is one of the most practical tools in cost accounting, because it connects fixed costs, variable costs and volume in a simple way. For IT financial management, it is especially useful for comparing options with different cost structures, such as owning infrastructure versus paying for cloud services, or flat-fee versus usage-based pricing, where the cheaper option depends on volume.

Definition of Break-Even Point

The break-even point is the point at which total revenue equals total costs. It is usually calculated in units by dividing total fixed costs by the contribution margin per unit, which is the price per unit minus the variable cost per unit.

A product with fixed costs of $500,000, a price of $50 and variable costs of $30 per unit has a contribution margin of $20, and breaks even at 25,000 units. Every unit sold beyond that contributes $20 to profit, and every unit short of it adds $20 to the loss.

Break-Even in Units and Revenue

Break-even can be expressed in units or in revenue. Break-even revenue equals fixed costs divided by the contribution margin ratio, which is the contribution margin as a share of price. In the example above, the ratio is 40 percent, so break-even revenue is $1.25 million.

The margin of safety measures how far actual or expected activity exceeds the break-even point. A large margin of safety means the activity can absorb a significant fall in volume before making a loss.

These measures are useful for internal services as well as products. An internal platform that must recover its costs through chargeback has a break-even level of consumption, below which its rates would not cover its costs.

Break-Even Between Two Options

Break-even analysis can also compare two options with different cost structures. The break-even point between them is the level of activity at which their total costs are equal. Below it, one option is cheaper; above it, the other.

This form of analysis is common in technology decisions. An option with high fixed costs and low variable costs, such as owned infrastructure, becomes cheaper at high volumes, while an option with low fixed costs and higher variable costs, such as usage-based cloud services, is cheaper at low volumes.

Knowing where the crossover lies, and how close current and expected volumes are to it, helps leaders choose the right option and know when to revisit the decision.

Importance of Break-Even Analysis in IT Financial Management

Technology costs combine fixed elements, such as staff, hardware and licenses, with variable elements, such as cloud usage and per-transaction fees. Break-even analysis shows how these combine as volumes change.

It is a simple but powerful way to compare sourcing options and pricing models.

It also helps explain to business leaders why the best option can change as the business grows.

Sourcing and Pricing Decisions

When choosing between owning infrastructure and using cloud services, break-even analysis shows the volume at which ownership becomes cheaper. The same approach applies to choosing between software licensing models, such as flat enterprise licenses versus per-user pricing.

Because volumes change over time, a decision that is right today may become wrong later. Break-even analysis makes it clear when to revisit a decision, for example when usage grows past the crossover point.

The analysis complements fixed vs variable costs analysis, which identifies the cost structure that break-even calculations depend on.

Evaluating Investments

For technology investments that reduce costs, break-even analysis shows how much activity is needed for savings to cover the investment, such as the number of automated transactions needed to justify an automation platform.

Time-based break-even, the point at which cumulative savings equal the investment, is closely related to the payback period and is often used in the same way.

Break-even analysis is also useful for setting minimum adoption targets for new platforms, since it shows the level of use needed for the investment to be worthwhile.