Financial Modeling Tutorials

- Financial Modeling Basics
- What is Financial Modeling?
- Financial Modeling in Excel
- Types of Financial Models
- Financial Modeling Interview Questions
- Alibaba IPO Financial and Valuation Model
- Box IPO Modeling Details
- Box IPO Valuation Model
- Download Alibaba IPO Financial Model
- Financial Modeling Books
- Financial Modeling Templates
- Financial Modeling Course

- Excel Modeling
- Financial Functions in Excel
- Sensitivity Analysis in Excel
- Time Value of Money
- Future Value Formula
- Present Value Factor
- Perpetuity Formula
- Annuity vs Perpetuity
- Internal Rate of Return (IRR)
- NPV vs XNPV
- NPV vs IRR
- NPV Formula
- IRR vs ROI
- Break Even Point
- Payback Period & Discounted Payback Period
- Payback period Formula
- Discounted Payback Period Formula
- Profitability Index
- Cash Burn Rate
- Simple Interest
- Effective Interest Rate
- Loan Amortization Schedule
- Rule of 72
- Geometric Mean Return
- Real Rate of Return Formula
- Continuous compounding Formula
- Weighted average Formula
- Holding Period Return Formula
- Cost Benefit Analysis
- Mortgage APR vs Interest Rate

source: which.co.uk

**Break Even** Point – Netflix recently crossed 100 million subscribers with more than half of them coming from outside of US. It added 4.693 million US customers and 14.341 million international in 2016. Certainly, Netflix is doing great on the subscribers’ count, however, **Is it breaking even? **

Break Even Point is an important thing to consider if you are just starting out with a venture or calculating the no profit and no loss point of a business. In this article, we will look at BEP analysis in detail. We also answer the Netflix break even question.

In this article, we will talk about the following –

- What is Break Even Point?
- Break Even Point Formula
- Interpretation of Break Even Point
- Break Even Point Examples
- Netflix Break Even Point for US Customers
- Netflix Break Even Point for International Customers
- Limitations of Break Even Point Analysis
- Conclusion

**Recommended Courses**

## What is Break Even Point?

When a person starts a business, his first question becomes – “When will I make a profit from this venture?” And if you learn Break Even Point (BEP) and how to calculate the units, you would be able to answer your question all by yourself. Suppose, you don’t own a business, but you have a job. What if you treat your job as a business and ask yourself – “When would I be able to recoup all my investments for getting this job and make more than what I invested?” This is a valid question. Break even analysis will show you how to calculate that point or the juncture since when you would start to make the profit.

Now, you may wonder how come it would be possible to get a precise amount or to know the exact timeline when there are so many variables in the market! True! It’s not as easy as it sounds. But still we can use Break Even Point (BEP) analysis to reduce the complexities and to understand the profit making point of your product or job through these simple methods.

Let’s have a look at the formula of Break Even Point analysis to understand the details of computation.

## Break Even Point Formula

In simple terms, the break-even point is the juncture where total cost and total sales (revenue) are equal. This point is important for every company to know because, from this point, the company starts to become profitable. Let’s have a look at the formula.

We will go step by step to understand the formula better –

If total cost and total revenue are equal at this point, that means the units produced would generate zero profit.

That means at this point,

Revenue – Total Cost = 0.

Now, let’s understand what total cost is.

Total cost = Variable Cost * N + Fixed Cost

Here, N = number of units produced.

Let’s look at the break-up of revenue now.

Revenue = Price per unit * N

If we put the value of total cost and revenue at the first equation, then –

- Revenue – Total Cost = 0
- Or, Price per unit * N – (Variable Cost * N + Fixed Cost) = 0
- Or, Price per unit * N – Variable Cost * N – Fixed Cost = 0
- Or, Price per unit * N – Variable Cost * N = Fixed Cost
- Or, N (Price per unit – Variable Cost) = Fixed Cost
- Or, N = Fixed Cost / (Price per unit – Variable Cost)

So, the break- even point is –

Now, this formula will give us the units required to produce break-even quantity where the total revenue and the total cost would be equal.

Here’s something else you need to pay heed to and that is contribution margin.

**Contribution Margin per unit = Price per unit – Variable cost per unit.****Contribution Margin = Total Revenue – Variable Cost.**

## Interpretation of Break Even Point

By understanding break-even point and break-even analysis, you would be able two things.

- First, you will be able to understand how many units you need to produce to break even. So that, you would be able to produce more unit and generate more revenue to make profits!
- Second, if you have a goal to achieve the desired profit, you need to do a back calculation and you would be able to find out how many units you need to produce to achieve that feat.

Break-even point is important for any company which is just starting out or which is thinking of investing its resources into a new project.

## Break Even Point Examples

As break-even point is such an important concept, we will take several examples to illustrate each part of the analysis. We will deliberately omit few things to understand BEP analysis better.

Let’s get started with the first example.

**Break Even Point Example # 1**

Let’s look at the details of two companies.

In $ |
Company A |
Company B |

Fixed Cost |
30000 | 50000 |

Price per unit |
100 | 90 |

Variable Cost per unit |
40 | 3 |

Now, let’s look at the Break-even point (units) to understand beyond which Company A and Company B would be able to make profits.

Remember the formula. Here it is –

BEP = FC / (Price – VC)

Putting the data in the formula, we get –

In $ |
Company A |
Company B |

Price per unit |
100 | 90 |

Variable Cost per unit |
40 | 30 |

Contribution Margin/unit |
60 | 60 |

Now, the BEP would be –

In $ |
Company A |
Company B |

Fixed Cost (A) |
30000 | 50000 |

Contrib. Margin/unit (B) |
60 | 60 |

BEP (A / B) |
500 | 833.33 |

That means beyond 500 units, Company A and beyond 833.33 units, Company B would be able to make profits.

Now, let’s swap things up and change what is known and what is unknown.

**Break Even Point Example # 2**

In $ |
Company A |
Company B |

Fixed Cost |
? | ? |

Price per unit |
120 | 140 |

Variable Cost per unit |
60 | 70 |

BEP (units) |
500 | 600 |

Now in this example, Fixed Cost is not known. But we have the information about BEP. Using the formula, let’s calculate the Fixed Cost now.

In $ |
Company A |
Company B |

Price per unit |
120 | 140 |

Variable Cost per unit |
60 | 70 |

Contribution Margin/unit |
80 | 70 |

The fixed cost would be then –

In $ |
Company A |
Company B |

Contrib. Margin/unit (A) |
80 | 70 |

BEP (B) |
500 | 600 |

Fixed Cost (A * B) |
40000 | 42000 |

Now let’s make things a little bit trickier so that the concept gets clear and we can understand BEP analysis from all angles.

**Break Even Point Example # 3**

In $ |
Company A |
Company B |

Total Revenue |
50000 | 60000 |

BEP (units) |
500 | 600 |

FC/VC |
3:2 | 4:3 |

FC |
? | ? |

Variable Cost per unit |
? | ? |

Contribution Margin/unit |
? | ? |

Now we have total revenue given, we know how much units we need to produce to be able to reach no profit, no loss zone and where total cost equals to total revenue and at the same time, we have a ratio given between fixed cost and variable cost, which will allow us to ascertain the fixed cost and variable cost per unit.

First, let’s start with total revenue. At BEP, total revenue equals total cost. That means the amount of total revenue is equal to total cost.

That means –

In $ |
Company A |
Company B |

Total Cost |
50000 | 60000 |

And as we already have total revenue and BEP units, we can calculate price per unit. Here’s the price per unit –

In $ |
Company A |
Company B |

Total Revenue |
50000 | 60000 |

BEP (units) |
500 | 600 |

Price per unit |
100 | 100 |

Now, let’s find out the fixed cost and the variable cost per unit.

Total cost = Fixed Cost + Variable Cost

We have been given information that, FC/VC for Company A is 3:2 and for Company B is 4:3.

Let’s calculate FC, VC per unit and Contribution Margin per unit for Company A –

FC/VC = 3/2

Or, 2FC = 3VC

Or, FC = 3/2VC.

Now putting the same in the total cost, we get –

50,000 = FC + VC

Or, 50,000 = 3/2VC + VC

Or, 50,000 = 5/2VC

Therefore, VC for Company A would be $20,000 and FC would be $30,000.

VC per unit for Company A would be = ($20,000/ 500 units) = $40 per unit.

Therefore, the Contribution Margin per unit for Company A would be = (Price per unit – VC per unit) = ($100 – $40) per unit = $60 per unit.

Let’s calculate FC, VC per unit and Contribution Margin per unit for Company B –

FC/VC = 4/3

Or, FC = 4/3VC

Now putting the value of FC in the equation of total cost, we get –

60,000 = 4/3VC + VC

Or, 60,000 = 7/3VC

Therefore, VC for Company B would be $25,714 (approx.) and FC would be $34,286 (approx.).

And VC per unit for Company B would be $42.86 per unit.

Therefore, the Contribution Margin per unit for Company B would be = (Price per unit – VC per unit) = ($100 – $42.86) per unit = $57.14 per unit.

In the last example, let’s calculate the BEP with the given information of desired profit.

**Break Even Point Example # 4**

In $ |
Company A |
Company B |

Fixed Cost |
30000 | 50000 |

Price per unit |
100 | 90 |

Variable Cost per unit |
40 | 30 |

Desired Profit |
10000 | 15000 |

In this example, we will calculate the BEP (in units) after considering the desired profit the companies need to earn. As the desired profit is a fixed amount, to ascertain the number of units which will earn the desired profit for both the companies, we would consider desired profit as addition fixed cost for the ease of calculation.

At the end, we would cross-check to see whether the units we have ascertained are accurate or not.

Now new fixed cost for both the companies would be –

In $ |
Company A |
Company B |

Fixed Cost |
40000 | 65000 |

Now, let’s calculate the number of units which will generate desired profits for both of these companies.

In $ |
Company A |
Company B |

Price per unit |
100 | 90 |

Variable Cost per unit |
40 | 30 |

Contribution Margin/unit |
60 | 60 |

In $ |
Company A |
Company B |

Fixed Cost (A) |
40000 | 65000 |

Contrib. Margin/unit (B) |
60 | 60 |

BEP (in units) (A / B) |
667 | 1083 |

So, at 666.67 units, Company A would be able to make $10,000 profit which it desired.

And at 1083.33 units, Company B would be able to make $15,000 profit as expected.

Let’s cross-check the information to understand whether the calculation produced accurate number of units for both of these companies or not!

In $ |
Company A |
Company B |

BEP (in units) (A) |
666.67 | 1083.33 |

Price per unit (B) |
100 | 90 |

Sales (C = A * B) |
66667 | 97500 |

Variable Cost per unit (D) |
40 | 30 |

Variable Cost ( E = A * D) |
26667 | 32500 |

Fixed Cost (F) |
30000 | 50000 |

Desired Profit (C-E-F) |
10000 | 15000 |

From the above calculation, it’s clear that BEP analysis produced the accurate number of units to produce the desired profit for both of these companies.

## Netflix Break Even Point for US Customers

Let us now look at the Netflix example and calculate its break even point.

source: Netflix SEC Filings

Netflix added 4.693 million in 2016, 5.624 million in 2015 and 5.694 million in 2014. Corresponding Marketing expenditure was $382.8 million in 2016, $317.64 million in 2015 and $293.45 million on 2014

- Acquisition Cost Per new user in 2016 = $382.8 million / 4.693 million = $81.6 per subscriber
- Acquisition Cost Per new user in 2015 = $317.64 million / 5.624 million = $56.5 per subscriber
- Acquisition Cost Per new user in 2014 = $293.45 / 5.694 million = $51.5 per subscriber

It is worth noting that Netflix is facing two major problems on the Domestic US front –

- Growth in subscribers is slowing down
- Aquisition Cost per subscriber has been increasing. Acquisition cost increased 50% in 2016 as compared to 2015.

Let us now calculate break even point of Netflix (to recoup the acquisition cost per domestic subscriber)

We will calculate break even point (months) for subscribers added in 2016. Please note that I am considering only two types of cost here

- Cost of Revenues
- Marketing Costs

There are other costs that flow from the Income Statement – like the General and Admin Costs, Other expenses, Interest Expense etc. In our calculation, we have excluded such expenses.

- Revenue per subscriber per month (2016) = $9.21
- Contribution Margin = 36% (Contribution is Revenues minus Cost of Revenues – Marketing Expenditure)
- Contribution per Subscriber = 9.21 x 36% = $3.32
- Total Amount Spend in acquiring the subscriber = $81.6
- Break Even Point (Months) = $81.6/3.32 = 24.6 months

**This implies that Netflix will take more that 2 years to breakeven on its domestic customers.**

## Netflix Break Even Point for International Customers

source: Netflix SEC Filings

Netflix added 14.341 million in 2016, 11.747 million in 2015 and 7.347 million in 2014. Corresponding Marketing expenditure was $608.24 million in 2016, $506.44 million in 2015 and $313.73 million on 2014

- Acquisition Cost Per new user in 2016 = $608.24 million / 14.341 million = $42.4 per subscriber
- Acquisition Cost Per new user in 2015 = $506.44 million / 11.747 million = $43.1 per subscriber
- Acquisition Cost Per new user in 2014 = $313.73 / 7.347 million = $42.7 per subscriber

In how many months will Netflix break even this acquisiton cost per international subscriber.

- Revenue per subscriber per month (2016) = $7.81
- Contribution margin for the company is negative in 2016

With Netflix is aggressively adding customers each year and negative contribution margin in 2016, we can only assume as of now that Netflix has a long way to go before they can think of breaking even on its international subscribers.

## Limitations of Break Even Point Analysis

BEP Analysis is based on many assumptions, thus most of the companies don’t rely much on BEP alone. They compute many other ratios to make a concrete decision. Here are few limitations of BEP Analysis –

- There are many assumptions we make while computing Break-even point. For example, we assume that the price of a product remains constant all the time; but in reality the price changes at the different output level of the product. We also assume that fixed costs remain same always; but even fixed cost changes after a certain output.
- One of the chief assumptions of BEP analysis to equate sales as output. But there may be a difference between sales and output. Not all output is not meant to get sold and there is a chance as well for normal or abnormal loss where few outputs get wasted.
- Most of the businesses have more than one product. Thus, it’s become tougher to calculate BEP.
- Variable cost per unit doesn’t always remain constant. It changes when the production is being done in a large chunk and thus the firm gets the inputs at much lower rate.

## Conclusion

BEP analysis is useful for businesses which have one product and which are just starting out their journey. However, it becomes complicated in the case of service industry or if the firm produces more than one product.

## Leave a Reply