7 Deadly Sins of Startups from a Valuation Perspective: No Break-even Analysis

A key part of the financial projections and business plan is for the entrepreneur to conduct a break-even analysis. The traditional break-even analysis reveals what level of sales a business must achieve to cover both the variable costs (cost of goods sold) and the fixed costs (overhead), resulting in $0 profitability. Beyond the break-even point, the business should be generating profits. Until the company reaches its break-even point, the business must have adequate financial resources to pay the bills and fund ongoing operations. Conducting a break-even analysis should enable the entrepreneur to test the reasonability of the business plan and financial projections. For example, if the business needs to produce and sell 5,000 widgets per month to reach break-even but the capacity is only 4,000 widgets per month, the entrepreneur has a significant problem and will either need to cut costs to lower the break-even point or increase capacity to produce more products. In addition to traditional break-even analysis, an entrepreneur may conduct a cash flow break-even, which shows how much must be sold for the business to begin generating positive cash flow.

A business appraiser will often consider the startup’s break-even point in the analysis of future returns and risk. The break-even analysis can make the difference between the business having a value of $0, implying the business won’t survive, and a positive value and future prospects.

 

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