What Is the Meaning of "Breaking Even" in Accounting Terms?
When talking to business owners or investors, the term "breaking even" is often used. "Breaking even" in accounting terms means that the total income a business earns equals the total expense of running the business. Many startup businesses budget for net operating losses for the first year or two of operations with the hopes that the business breaks even or shows a profit instead. A business needs to show a profit by the third year in order to give the owner confidence that the business can be successful.
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The Facts
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To determine whether a business is breaking even, you need to review an income statement. An income statement is a detailed report of all income less expenses for a specified period of time. The difference between income and expense is usually referred to as "net income" or "net loss." However, if the difference is zero, then the business is breaking even, meaning there is no net income or loss to report.
Time Frame
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Income statements are generated each month after all the accounting transactions are verified and reconciled. Accounting software can also generate income statements quarterly and annually. If annual income less annual expense is zero, then the business broke even for the year.
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Misconceptions
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People who lack a good understanding of general ledger accounting often assume that a business doesn't generate cash flow if it breaks even. That is not always the case. Income statements contain certain expenses such as depreciation that are reflected as a cost on the income statement but do not require an actual cash outlay. For example, a business with $5,000 in income and $5,000 in expense, of which $1,000 is depreciation, will break even on the income statement but might have $1,000 in cash flow.
Prevention/Solution
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Breaking even is not a desirable performance for any business, except perhaps in the first two years. If a business breaks even, owners should review all avenues to increase revenue as well as reduce costs in order to generate a profit. A business that doesn't eventually generate a profit will not remain in operation very long.
Expert Insight
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In order to determine profitability, smart business owners prepare a break-even analysis before opening a business. To prepare a break-even analysis, make a detailed list of all projected expenses for the business for one month. Divide the total expenses by the billing price of your product or service to determine how many units of your product or service you have to sell in order to break even. Consider the number of units required to break even in relation to the potential consumer market in order to decide whether the business is viable.
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