What’s the Difference Between the Break-even Point and the Profitability Threshold?

In today’s highly competitive and rapidly evolving environment, particularly in the outdoor and sports retail sectors, it’s essential for businesses to grasp and master key concepts like the break-even point and profitability threshold. These two financial indicators play a crucial role in making strategic decisions and managing costs effectively. They help companies determine the level of sales required to cover their costs and begin generating profits.

In this article, we’ll take an in-depth look at the difference between the break-even point and profitability threshold, their importance in the financial management of your store network, and how to perform the right calculations to implement the necessary business strategies.

1. Analyzing the Profitability Threshold

What is the Profitability Threshold?

The profitability threshold is a financial metric that helps determine the level of revenue at which a business starts making a profit, meaning it covers both fixed and variable costs. It represents the balance between a company’s income and expenses. Below this threshold, the company is operating at a loss; above it, the company turns a profit.

For a network of stores, the profitability threshold is a critical tool for assessing the financial health of the entire group. By calculating this threshold, managers can identify the minimum revenue each store needs to achieve in order to avoid generating a loss. This allows for strategic decisions on cost management, pricing, sales promotions, and more.

The benefits of knowing the profitability threshold are numerous:

• It helps evaluate the overall profitability of the stores within a brand by identifying which locations contribute most to profits and which are underperforming;
• It facilitates strategic decisions such as store openings, closures, or operational reorganizations;
• It identifies the specific costs associated with each store, helping to optimize the profitability of the network;
• It serves as a valuable tool for short- and long-term financial planning, aiding in assessing the company’s viability and setting realistic revenue targets.
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How to Calculate the Profitability Threshold?

The profitability threshold is calculated based on your business’s fixed and variable costs. To recap:

• Fixed costs, or structural costs, are stable, recurring, and predictable. They include rent, salaries, depreciation, insurance premiums, etc.
• Variable costs, or operating expenses, fluctuate based on business activity and sales. These include stock purchases, distribution expenses, energy costs (electricity, fuel, etc.).

The formula for the profitability threshold is as follows:

Profitability Threshold = Fixed Costs / (Unit Selling Price − Variable Cost per Unit​)

To calculate your margin rate on variable costs, first determine your revenue and subtract the variable costs from it.

2. Break-even Point: Definition and Importance

What is the Break-even Point?

The break-even point estimates the minimum amount of time your store network needs to operate in order to reach zero profit or loss. While the profitability threshold determines the total revenue required to reach this point, the break-even point focuses on the number of days of sales needed to cover costs. It indicates the exact date when your business becomes profitable and helps you set minimum commercial targets, such as the number of clients or sales per day, daily revenue, etc.

How to Calculate the Break-even Point?

The break-even point is another way to express the profitability threshold, depending on how you choose to use this indicator for your business. It can also be expressed as the number of units you need to sell to reach your profitability threshold.

The formula is as follows:

Break-even Point = Profitability Threshold​ / Average Daily Revenue

3. Strategies to Reach and Exceed the Profitability Threshold

To improve your profitability threshold, the main goal is to reduce your fixed costs and/or increase the margin on your variable costs. Several strategies can help you achieve this.

Analyze Your Expenses to Optimize Fixed Costs

With a clear understanding of your structural costs, you can identify the most expensive activities and make informed decisions to reduce expenses: renegotiate terms with partners, switch suppliers, and more. By using a performance tracking tool for your stores, you can quickly identify profitability issues and address them, driving both performance and network growth.

Increase the Margin on Variable Costs

There are several ways to increase your margin on variable costs:

• Renegotiate purchase prices with suppliers to secure better terms and preferential rates;
• Improve logistical efficiency to reduce costs related to stock management, transportation, and product distribution;
• Implement strict procurement management to avoid overstocking, minimize losses from unsold goods, and optimize variable costs;
• Closely examine the different categories of variable costs to identify optimization opportunities and implement corrective measures;
• Increase sales volume and/or prioritize high-margin products in your sales strategy to improve overall profitability;
• Continuously monitor the financial performance of the store network, analyze margins for each product or product category, and adjust prices and promotions based on results.
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4. Practical Applications

Example of an Unprofitable Company

Let’s look at an example from a bicycle shop. The financial details for one year are as follows:

• Annual fixed costs: €60,000
• Selling price per bicycle: €300
• Variable cost per bicycle: €200
• Number of bicycles sold during the year: 250

Let’s first calculate the store’s annual revenue:

Revenue = Selling Price × Number of Bicycles Sold 

Revenue = 300×250 = 75,000€

Next, let’s calculate the store’s profitability threshold:

Profitability Threshold = Fixed Costs / (Selling Price−Variable Cost per Unit)

Profitability Threshold = 60,000€​ / (300€−200€) =  60,000€​ / 100€ = 600 bicycles

This means the store needs to sell approximately 600 bicycles in a year to cover its fixed costs and reach the profitability threshold. However, with only 250 bicycles sold, the store falls well short of its break-even point.

This indicates that the store is unprofitable because its sales aren’t sufficient to cover fixed costs. Using this calculation, the store can identify the minimum sales level needed to break even and take corrective measures, such as reducing costs, increasing sales, or diversifying its product range to improve its financial situation.

Example of a Profitable Company

Let’s revisit the example, but this time assume the store is profitable. Here are the details:

• Annual fixed costs: €50,000
• Selling price per bicycle: €400
• Variable cost per bicycle: €250
• Number of bicycles sold: 300

Let’s first calculate the store’s annual revenue:

Revenue = Selling Price × Number of Bicycles Sold

Revenue = 400×300 = 120,000€

Next, let’s calculate the profitability threshold:

Profitability Threshold = Fixed Costs / (Selling Price−Variable Cost per Unit)

Profitability Threshold = 50,000€/ (400€−250€) = 50,000€​ / 150€ = 333,33 bicycles

This means the store needs to sell approximately 334 bicycles to break even. In this example, the store sold 300 bicycles, slightly below the break-even point, but it still managed to generate profits.

Thanks to strong revenue, the store can cover its fixed costs and even generate a profit, despite selling fewer bicycles than needed to break even. This indicates that the company is well-managed and operates efficiently.

In this case, calculating the profitability threshold allows the manager to understand their safety margin and assess the company’s ability to generate profits even with fluctuations in sales. This key indicator helps businesses make strategic decisions to optimize costs, boost profitability, and ensure long-term sustainability.

Managing both the break-even point and the profitability threshold is crucial for a company’s financial health. These tools allow you to determine the sales level required to cover all fixed and variable costs and start generating profits. By identifying these thresholds, you can make informed decisions about your pricing, cost management, and commercial strategy, ultimately improving profitability. These calculations also help assess the performance of your store network, anticipate risks, and plan long-term activities. Therefore, it’s vital to use the right tools and metrics to track the financial health of your stores accurately.