I want to start with the definition we've used in this course for

financial sustainability for a company that sells things.

The basic condition that's required for financial sustainability is that

the quantity sold times the difference between the price and

the cost of each unit has to exceed the fixed costs of operating the business.

Put simply, P minus C, or price minus cost is the gross margin, that's how

much you make on each unit of product and the quantity sold is the quantity sold.

The quantity sold times your profit per unit,

that must exceed the fixed cost of operating the business.

If you can achieve that, then you can achieve financial sustainability for

the business.

In setting breakeven quantity, we simply turn that around and ask the question,

how many units would be required for us to cover our fixed cost, F?

That can be expressed by the expression, quantity Q,

breakeven quantity Q is equal to the fixed cost per unit period F

divided by the profit margin per unit sold, or P minus C.

Let me give you a numerical example to make that clear.

Let's imagine that it costs us $300,000 per year to operate the business.

These are the costs that don't vary with the quantity sold,

this is things like rent, advertising,

salaries we pay to the bookkeeper and to the marketing person.

Let's say that's $300,000 per year and

let's imagine that we sell these at a price of $25 and

that they cost us $13.44 to make.

That our breakeven quantity would be 300,000 divided by

the difference between $25, our price, and 13.44, our cost.

If you do that arithmetic, it comes out to 25,952 units per year or

more typically, it's expressed monthly, so it'd be 2,163 units per month.

The breakeven analysis simply says,

we have to sell a little bit more than 2,000 units per month,

about 2,200 units per month in order to cover the nut, in order to breakeven.

Now if you don't sell a product and

instead sell a service, then with recurring revenues and

recurring customers, then you think about it just a little bit differently.

I'm also an investor in a company called Gridium that sells software to companies

that manage commercial office buildings and they sell it on a subscription basis.

They have a couple of different subscription plans but

some of them cost $79 a month, some of them cost $150 per month.

It's essentially the same analysis but

instead of asking how many transactions do we need to have per month,

you ask how many customers do we have to have in our system,

on our system, subscribing to our service to cover the fixed cost?

So, a very similar kind of analysis,

I don't think you'll have any trouble doing it.

But I do want to point out that it's a little bit different for recurring

services like you see in software service businesses or in other kinds of services.

Now, there are some issues in breakeven analysis.

It's fairly useful as a way to just test your intuition

of how much business would we really have to do to sustain

a company of the size we're imagining this business to be?

It's good for calibrating your intuition around the feasibility of a new business

but it does assume a fixed level of spending.

It assumes that F, in fact, is fixed but those costs aren't really fixed.

Those costs are the results of a managerial decision

based on how big you think the company can be, how much resource you think you're

going to need over the coming months in order to support that business.

The breakeven calculations are probably best framed as, if we were

this size of an organization, if we made this kind of commitment to rent and to

payroll and to advertising, how many units would we have to sell to cover the nut?

How many units would we have to sell to breakeven, to cover those fixed costs?