Revenue Break-Even Point

Definition

The term revenue break-even point describes a calculation analysts can use to determine the level of revenues at which a company remains profitable.  The higher a company's actual revenues are above their break-even point, the higher is their potential profitability.

Calculation

Revenue Break-Even Point = Operating Expenses / Gross Margin

This ratio can also be determined on a cash flow basis, which removes all non-cash expenses such as depreciation and amortization.

Revenue Break-Even Point = (Operating Expenses - (Depreciation + Amortization + Other Non-Cash Expenses)) / Gross Margin

Explanation

Also known as the sales break-even point, the revenue break-even point provides the investor-analyst with insights into the profitability of a company.  The ratio can be used to estimate the increase in profits that result from a potential acquisition.

The company's management team can also use this measure to understand the maximum amount of profits that can be generated when operating at their maximum revenue producing capacity.  The measure can model profits when faced with the option of expanding the revenue producing capacity of the business.

Since production cost can vary over time, analysts as well as the company's management team should track this measure over a number of reporting periods.  This will smooth out any short-term irregularities in the reporting of operating data.

Example

Company A has excess capacity at one of their production facilities and the company's management team has been asked to model the potential impact to profits if the company were to sign a contract with Company XYZ that would consume the remaining capacity at that plant.  Company A's current revenues are $7.25 million, with operating expenses of $2.125 million and a 35% gross margin.  The table below shows the company's break-even point before signing the contract with Company XYZ.

Break-Even Analysis (000s)
Current Revenues $7,250
Operating Expenses $2,125
Gross Margin 35%
Break-Even Point $6,071
Maximum Profit Potential $413

Note:  The maximum profit potential is derived by subtracting the break-even point from current revenues and dividing that value by the gross margin percentage.

The table below shows the company's break-even point after signing the contract with Company XYZ.

Break-Even Analysis (000s)
Current Revenues $9,000
Operating Expenses $2,638
Gross Margin 35%
Break Even Point $7,537
Maximum Profit Potential $512

As the above table demonstrates, Company A could realize nearly $100,000 in profits by signing the contract with Company XYZ.

Related Terms

discretionary costs to sales ratio, foreign exchange ratio, interest expense to debt ratio, overhead rate, goodwill to assets ratio, overhead to cost of sales ratio, investment turnover ratio, revenue margin of safety, operating assets ratio