Most early-stage entrepreneurs only begin thinking about break-even point after they have started a venture.
However, calculating your estimated break-even point before starting a venture will allow you to be better informed as to whether it can be successful or not.
What is break-even point?
Break-even point is reached when revenue equals expenses.
Essentially, you are no longer losing money while operating your business once it reaches break-even point.
The graph above would suggest that every company reaches break-even point – but the truth is that very few do. This is because you only have a limited amount of time to reach break-even point – because generally the temporary losses are coming out of your bank account and that is not bottomless.
The limited amount of time that you have to reach break-even point is referred to as your “runway”.
Runway – explained
Example
In the above graph, the person has €20,000 in savings and spends €2,000 per month – they officially have 10 months runway (20,000/2,000=10) until they reach €0 and need to do something else.
So break-even point must be reached within 10 months or the business idea is bust.
To calculate your runway, you’ll need to know:
– business expenses per month
– personal expenses per month (and how much of a salary is needed to support these)
– estimated revenue per month
Why you should calculate your break-even point before starting your business
1) Business model choice
Different business models are likely to have different break-even points.
The simpler your product or service, the sooner you can earn revenue and the less expenses you will have – and thus, the shorter your journey to reaching break-even point.
Circumstance A
If you estimate that it will take 5 months to reach break-even point and you have 6 months runway – then you have a chance of reaching break-even point within your runway – thus creating a successful business.
Circumstance B
If you estimate it will take 6 months to reach break-even point and you only have 4 months runway – you should try a different business idea!
2) Decide whether you need investment or not
Sometimes when you calculate your break-even point and your runway before starting your venture, you will realise that you may not have enough time to get your business off the ground (like in Circumstance B above).
When this happens, you can either:
1) change your business idea to one that fits your more limited runway
2) plan to raise investment to extend your runway
It’s good to decide this before you start your venture so it’s done out of preference rather than necessity.
Conclusion
Business ideas are so exciting in the early stages.
It may seem like a major buzz kill to talk about runways, break-even points and numbers in general.
However, paying attention to the numbers of any business idea from an early stage will make it a lot more likely to last well into the future.
Thank you for reading,
Gary
