A cash break-even analysis uses an equation that is similar to a standard break-even calculation. The difference is that the cash break-even analysis removes non-cash expenses, causing a different result and providing analysts with additional insight into a firm's financial condition.
The cash break-even point shows a firm's minimum amount of revenue from sales that are required to provide the business with positive cash flow. A cash break-even analysis starts with the cash break-even point equation. To calculate, start with a company's fixed costs and subtract depreciation. Take this result, and divide it by the contribution margin per unit. The contribution margin is equal to the sales price for one unit of product minus the variable costs needed to produce that unit.
Most companies have a limited amount of available cash. Additionally, holding on to excess cash requires companies to pass on other opportunities that may be lucrative, which costs the company money in lost opportunities if it continues holding onto the cash. With cash break-even analysis, a company can find the volume of sales it needs to generate to cover all of its cash expenses during a given period.
Fixed Costs and Depreciation
To calculate the cash break-even point, depreciation charges must be removed since they do not involve cash. When running the calculation, the cash break-even point is lower than a standard break-even calculation since depreciation is deducted and the fixed asset base is subsequently reduced.
Suppose a company sells products for $25 each, and has variable production costs of $15 to produce each unit. In addition, the company has fixed costs of $50,000, and $2,000 of the fixed costs is depreciation. The calculation starts by setting the $25 unit cost equal to the sum of the $15 unit variable costs and fixed costs less depreciation, or $48,000. The equation is restated by subtracting the $15 variable cost per unit from each side of the equation, to set the result to a $10 unit cost that is equal to $48,000 of net fixed costs. Dividing each side of the equation by the $10 unit cost returns a result of 4,800. This result shows that the company must sell 4,800 units of product at $25 each in order to meet its cash break-even point.