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A breakeven analysis is a common quantitative calculation you’ll perform in case interviews. You may need to conduct a breakeven analysis when you are determining whether a company should enter a new market, launch a new product, or acquire a company.
A breakeven analysis helps a company to determine whether or not they should make a particular business decision. All companies have a goal of being profitable from the decisions that they make.
By looking at the circumstances that need to be true in order for a company to recoup its investment costs, a company can see how likely it is that they will be profitable.
If the conditions for breaking even are favorable, a company may decide to pursue an investment. If the conditions for breaking even are unfavorable, the company may decide to pursue something else.
In this article, we’ll cover:
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By definition, breakeven occurs when a company earns as much money as it has spent. In other words, breakeven occurs when the revenue generated from operations has grown to the point that the company has recouped all of its costs.
To get the formula for breakeven, we set profit equal to zero. This is the same thing as setting revenue equal to costs.
Profit = Revenue – Costs
$0 = Revenue - Costs
Revenue = Costs
We can further breakdown revenue as the product of price and quantity of units sold. We can also breakdown costs into variable costs and fixed costs. Remember that variable costs is equal to the quantity of units sold times the variable cost per unit.
Quantity * Price = (Quantity * Variable Cost) + Fixed Costs
We can simplify this formula to get our formula for breakeven analysis.
Fixed Costs = (Price – Variable Cost) * Quantity
This is the only formula you need to know to solve any breakeven problem in a case interview. You should memorize this formula so that you will not need to derive it from scratch during a case interview.
However, if you understand the intuitive meaning behind this formula, as explained in the next section, you won’t even need to memorize it.
To understand the breakeven formula better, let’s go through each of the terms.
Fixed costs are costs that the company has to incur regardless of how many units of product are produced. Fixed costs include:
Variable costs are costs that increase as the number of units produced increases. They are costs associated with directly producing a unit of product. Variable costs include:
Price is the amount the product is being sold for. In other words, it is the amount of money the company receives for each unit sold.
Finally, quantity is the number of units of product that are sold.
Here is how to understand the formula intuitively in your case interviews.
For each product sold, the company makes an amount of profit equal to the difference between the product’s price and variable cost. If you multiply this by the quantity of units sold, this is the total profit the company makes.
However, the company has fixed costs that it has paid for or needs to pay for. Therefore, the profit made from selling product has to at least equal fixed costs in order for the company to actually be profitable.
If you can understand the concept of breakeven from this perspective, you should be able to immediately recall the breakeven formula in any case interview situation.
The breakeven analysis formula has four different terms. When given a breakeven analysis problem in case interview, you’ll typically know three of these terms and be asked to solve for the fourth term that is unknown.
Therefore, there are four different types of questions you could be asked.
Breakeven Analysis Example #1
You operate a lemonade stand that sells a cup of lemonade for $4. The cost to produce a cup of lemonade is $1. To legally operate a lemonade stand, you had to purchase a permit for $600. How many cups of lemonade do you need to sell to break even?
Fixed Costs = (Price – Variable Cost) * Quantity
$600 = ($4 - $1) * Quantity
$600 = $3 * Quantity
Quantity = 200
You will need to sell 200 cups of lemonade.
Breakeven Analysis Example #2
Your company produces and sells widgets. Each widget costs $500 to produce. You have $100,0000 in fixed costs and expect to be able to sell 1,000 widgets. What minimum price do you need to set for your widgets to break even?
Fixed Costs = (Price – Variable Cost) * Quantity
$100,000 = (Price - $500) * 1,000
$100 = Price - $500
Price = $600
You need to price your widgets for at least $600.
Breakeven Analysis Example #3
A pharmaceutical company is considering investing money to research a new drug. They believe they can sell 10,000 units of this drug for $201 each over the course of the drug’s lifetime. The cost to produce each drug is $1. How much does the company need to keep research costs under in order to generate a profit?
Fixed Costs = (Price – Variable Cost) * Quantity
Fixed Costs = ($201 - $1) * 10,000
Fixed Costs = $200 * 10,000
Fixed Costs = $2,000,000
The company needs to keep fixed costs under $2,000,000.
Breakeven Analysis Example #4
Your company is a roofing tile distributor. You purchase roofing tiles from suppliers and sell them to retailers for a profit. Your annual fixed costs are $100,000. Each tile that you sell is priced at $1 and you sell ten million tiles a year. What is the maximum price per tile that you can purchase tiles for and still break even?
Fixed Costs = (Price – Variable Cost) * Quantity
$100,000 = ($1 – Variable Cost) * 10,000,000
$0.01 = $1 – Variable Cost
Variable Cost = $0.99
You can purchase the tiles for $0.99 each at most.
During your case interview, follow these tips to ensure that your breakeven analysis proceeds smoothly.
1. Make sure to include all costs
When doing breakeven analysis, it is important that you include all of the potential costs involved in managing and operating the business. Leaving out even a single cost element will change your answer.
2. Distinguish between variable costs and fixed costs
Whether a particular cost is a variable cost or a fixed cost can drastically change your answer. Therefore, ensure that you are correctly identifying each cost as either a variable cost or fixed cost.
The simplest way to assess this is to determine whether the cost element would increase if an additional unit is produced. If it does increase, then it is likely a variable cost. If it does not increase, then it is probably a fixed cost.
3. Check that price is greater than variable costs
It is impossible for a company to break even if its variable cost per unit is greater than the price that it charges for its product. Therefore, if you observe that price is less than variable costs, know that there is no way for the company to break even.
4. Talk the interviewer through each of your steps
Whenever you are doing math during a case interview, you want to make it as easy as possible for the interviewer to follow what you are doing. So, before you begin doing any calculations, walk the interviewer through your approach.
Start by explaining the breakeven formula that you are going to be using. Then, as you perform each calculation, talk through exactly what you are doing out loud.
This is beneficial for two reasons. One, you’ll be less likely to make math mistakes if you are talking through the calculations out loud. Two, it will be easier for the interviewer to give you hints or help you out if they know exactly what you are doing.
5. State the implications of your answer
Once you finish calculating your answer, don’t just stop there. Remember, the purpose of a breakeven analysis is to help a company determine whether it should make a particular investment.
Based on the answer that you calculated, do you think the company can realistically achieve the conditions to at least break even? If so, you could hypothesize that the company should make the investment. If not, you should consider what the company could do to increase the likelihood that it will be profitable.
Stating the implications of your breakeven analysis demonstrates that you are a proactive problem solver. This is a quality that separates outstanding case interview candidates from average candidates.
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