The third topic in the final session is "Break-even point"
Have you heard about Break-even point?
We are going to talk about the Break-even point mainly in this session
But before we go into the Break-even point,
I want to give you a hypothetical startup situation
that helps you to understand the balance sheet and income statement
Do you remember the hypothetical situation in the previous session?
We started AI-based online tutoring service
which CEO Tom started company with CFO Greg and CMO Rachel
This was the situation that they met together
and discussed about the income statement and the balance sheet
Let's look at the cartoon
I asked the Chat-gpt to draw the cartoon style scenario
Tom says, "We need to build five years projections"
Five years projection means
thinking about what will happen after five years
how our income and costs will change
Basically, you should guess those numbers
based on realistic assumption
Greg says, "Okay, let's start with assumption for revenue growth"
Then Rachel says, "I have some ideas for expanding our user base"
The CFO Greg started explaining the financial structure
He says, "I will go first
I've structured the financial model around the two revenue streams
The first one is B2C premium subscription business model to the individual consumers
Second one is B2B software as a subscription
licensing fee to the private academia"
We have many private educational institutions
We say it, private academia
We license our software to the private academia
This is kind of B2B
Then there is assumption,
year 1, we can achieve $50,000 as a one-year revenue
What about five years later?
For five years revenue, we will achieve at least $6.5M
This is a very ambitious revenue target
Monthly average revenue per user is $8
If we make a contract with the private academia,
we get $400 per month per institution
CAC means consumer acquisition cost
Consumer acquisition cost is an average of $25 to get one individual consumer
We should pay at least $600 as an average cost to get one private institution
Now we understand that
Annual churn is 30%
30%(B2C), 15%(B2B) mean
70%(B2C) of our existing consumers will continue using our product
85% of our B2B consumers will continue using our product
This is the opposite of the retention rate
He lists the assumptions
when he calculated a five-year income statement
Then he prepared a five-year income statement projection
Year 1: $500,000, and by Year 5, we will achieve $6.5M in revenue
This is a cost based on our consumers
Then, we can get gross margin and total
This is our profit
We expect to have these profits
For example, Year 1, our profit should be negative,
Year 2 should be negative
Year 3, we will achieve a breakeven point
Later, we are going to talk about what the breakeven point is
Year 4, we will get the positive $600,000 as a profit
Year 5, we will get $1.8M as profit
It has not happened yet
This could happen later
This is a kind of projection
What kind of projection?
Income statement projection
When you meet your investor,
you should prepare an income statement
for at least three to five years of projections
Rachel says, "We will need a marketing budget,
as soon as possible to meet these numbers"
Let's assume we raise a Series A in Year 2 to cover expansion
Good idea, I will finalize this into the visual income statement
Before we we meet the investors
This is how we use the income statement
After meeting with the investor, Greg says, "All right,
as part of our fundraising preparation,
Investors are requiring a balance sheet
They ask us to provide the balance sheet
Do you remember what the balance sheet is?
There are assets, debt, and equity,
balance sheet is a kind of snapshot
Income statement shows business performance from revenue to profit
Rachel asks, "But we already have the 5-year income statement
Why do we need the Balance Sheet too?"
She asks some fundamental questions
Then Greg says, "Balance Sheet shows where we are
It's a snapshot
Investors want to evaluate our current financial health"
Then Greg shows the balance sheet of our company
Here it is
Our total asset is $150,000, and our debt, $90,000
This money probably came from the bank
Our equity, $60,000
Put together, the debt and equity
How much? $150,000
Do you remember the balance sheet equation?
Asset should be same as debt+equity
The asset, $150,000, is same as debt+equity, $150,000
It's totally same
We made a great and perfect balance sheet, and it's accurate
What's this? Cash
Among the assets, we had $85,000 as cash
It means $85,000 left as a cash
What about remaining $65,000?
We already spent the $65,000 on other materials, such as PCs, working tools, and tables
We purchased these things
In order to purchase these things, we already spent $65,000
But we had those materials in our company
So, tables, tools, all are included
we call them assets, because assets are what we have
What we have are PCs, tools, tables, and our cash
Cash left $85,000
Now we understand how to interpret the balance sheet
Then, Rachel asks again, "So our debt makes up more than half of our total asset"
Isn't it?
Yes, our total assets are $150,000,
but our debt exceeds 50% of total assets
"Should we be worried about that?
What will investors think about this portion?"
Greg responded, "That's a fair concern, but
we still have $85,000 in cash,
which means we've got plenty of the runway left"
CEO Tom added, "We're just early stage
We will emphasize that we are managing cash efficiently
while building product and transaction
Then we can persuade our investors, don't worry about it"
This is the meaning of the balance sheet
Now we understand how to interpret
income statement and balance sheet
and how to use income statement and the balance sheet,
and how it looks in the meeting about the financial terms
inside the startup
Now we are going to talk about the breakeven point
What is breakeven point?
Breakeven point is the indication of
how much you need to sell
please remember the word,
how much or how many you need to sell in order to pay
for your fixed investment, your fixed cost
So far, we have discussed about one-time cost and ongoing cost
Do you remember that?
One-time cost is one of the cost that we pay,
and once you paid this money,
then we don't have to worry about the one-time cost
because one-time cost is just only once
Ongoing cost, on the other hand, we should pay regularly,
like a monthly rent fee, and utility fee
This is an ongoing cost
How can we distinguish these two costs?
We can distinguish these two types of costs based on regular payment
If we pay regularly, it is an ongoing cost
If we don't have to pay regularly, it is a one-time cost
Do you understand that?
What about fixed cost?
There are two additional types of costs
They are of different types
That costs depend on whether they are linked to your usage
For example, the first one is fixed cost
Fixed cost is the cost that stays the same
It means that this cost is a flat cost
No matter how many units of a product or service sold,
you pay this money
For example, you have a room and you should pay monthly
In this particular month, you never use your room
because you travel a lot
but you should pay the same rent fee, why?
Because your rent fee is already fixed
Although the rent fee is an ongoing cost
because you should pay monthly,
this cost is a fixed cost because it is already a flat fee regardless of your usage
But some cost is related to your usage
This is called a variable cost
Variable costs can change with the number of units produced and sold
The variable cost is a cost that is linked to your usage
For example, the gas fee or utility fee,
Although utility fees like gas fees, electricity fees, water fees, are ongoing costs,
this cost changes based on your usage
You see the difference between fixed costs and variable costs
Now, we are going to talk about this fixed cost
and variable cost in order to calculate the breakeven point
In order to calculate the breakeven point,
we need to calculate contribution margin
How do we get the contribution margin?
Contribution margin can be calculated by
price per unit - variable costs per unit
So, in order to calculate the contribution margin,
you need to know your price per unit and your variable cost per unit
How to calculate the breakeven point?
Once you calculate the contribution margin,
then you can use the contribution margin(in the formula)
Breakeven point can be calculated by Fixed costs / Unit Contribution margin
I will give you an example
So, you are a producer of head rack
In order to produce this head rack,
you use a machine for the plastic
Like this, this is the machine for the plastic,
and this is your final product, which is the head rack
Then, how much is the machine?
This machine costs $100,000
In order to start your business, you should purchase this machine first
It means you paid this machine already
How much? $100,000
Regardless of the product you made,
you paid $100,000 already
Although you do not use this machine at all,
your money is already gone
because you already purchased this machine
This is a kind of fixed cost
How much is your fixed cost? $100,000
Probably you can pay back monthly
This is your monthly ongoing fixed cost
If you pay this machine with your cash one time,
there is a one-time cost for the fixed cost
Do you understand the relationship?
This is your final product, which is a head rack
You will put the prices, how much? $75
For each unit, you can say $75
Now we need the number of variable cost
You calculate your variable cost
Then you can get your variable cost per unit
How much in this case?
Let's say $22
$22 as a variable cost includes
some electricity, water, salary to make one head rack
This money can be changed
based on your usage of salaries, water, electricity, etc.
We got all the numbers that we need
We know the fixed cost, prices, variable cost per unit
Then we are ready to calculate our breakeven point
How to calculate our breakeven point?
It's pretty easy
Breakeven point can be calculated by
fixed cost / contribution margin
So, how to calculate the contribution margin?
Contribution margin is calculated by Price per unit - Variable cost
In this case, price $75 - variable cost per unit $22
Then our contribution margin would be $53
$53 is the contribution margin
Let's go back to the calculation of breakeven point
How to calculate it?
Breakeven point can be calculated by
fixed cost / contribution margin
We got the contribution margin
We have fixed cost $100,000 divided by our contribution margin
How much? $53
Then we can get the breakeven point, which is 1,887
Please remember 1,887
This number represents the number of product, not a dollar
So, 1,887 product
What do you mean by that?
In order to reach out the breakeven point,
we should sell at least 1,887 head racks
What do you mean by that?
In order to cover our $100,000 as a fixed cost,
we should sell at least 1,887 head racks
Then later, all the money goes to positive(+)
Before then, all the money could be negative
because we already spent $100,000
Do you understand that?
That's why breakeven point is important
I want to give you another example
When I was in New York City,
I participated in hypothetical business competition
We teamed up and we came up with a hypothetical product
And then, we set the manufacturer's price at $89.99 as a retail price
We calculated our fixed cost, which is $85,000
There are several costs involved,
product development, application development, molding, packaging
Later, we calculated variable cost per unit, which is $75.5
It includes direct unit cost, shipping cost, and other variable costs
Then, we tried to calculate our breakeven point
It is possible because we know all the numbers that we need
For example, we know the number of prices, the fixed cost, the variable cost
How to get our breakeven point?
Do you remember the equation of the breakeven point?
Breakeven point can be calculated by fixed cost / contribution margin
How to get the contribution margin?
It's pretty easy
Contribution margin is price - variable cost
Let's get the contribution margin first
Our contribution margin is, price $89.99 - cost $75.5
Then, contribution margin is $14.49
Now we got the contribution margin
Then how do we calculate our breakeven point?
Breakeven point can be calculated by fixed cost / contribution margin
How much is it?
Our fixed cost is $85,000
Then, divided by our contribution margin, $14.49
Then, how much do we get?
5,866 units
This is our breakeven point
It means in order to achieve our breakeven point,
we should sell at least 5,866 units
In other words, in order to cover our fixed cost, which is $85,000,
we need to sell at least 5,866 units
Then our investors will probably ask when to achieve this breakeven point
How long it'll take to achieve the breakeven point
We need to guess several, the numbers
For example, first quarter, we cannot sell anything
But after three months, we can probably sell, though not for sure, 100 units
After six months, we can probably sell at least 1,000 units
By accumulating, we can achieve 5,866 units at some point
Look at this graph
Well, for the first to second week, we cannot sell anything
But after two and a half quarter(2.5Q),
We can start selling our product
We can achieve the breakeven point here,
which is, we can sell 5,866 units around that time
So I think it will take one year and four months
One year and four months later, we can achieve the breakeven point
This is the cartoon-style scenario based on
hypothetical business cases, which is AI-based online tutoring service
CEO Tom says, "I just got off a call with one of the VCs
They asked us to clearly define our break-even point
they want to know when we'll stop burning cash
Then Rachel says, "That's an important metric,
but for us, it's a little more nuanced"
We're subscription-based businesses
Subscription-based, AI-driven Software as a Service product
so the break-even analysis isn't different from traditional businesses
Using our cost structure and projected ARPU,
our break-even point can be based on
both B2C paying consumers and B2B private academia
I prepared for the breakeven calculation
Our fixed cost, it can be monthly
It's ongoing fixed cost
In this case, salary
Regardless of the services, we pay the same salary monthly
And cloud infrastructure, AI modern maintenance support
Put together, our fixed cost would be $70,000
What about our variable cost for two users?
Variable cost for two users, B2B users, B2C users
Variable cost for per user is $2
And we will charge $10
$10 is revenue, prices
That is prices
Variable cost would be $2
We can calculate the contribution margin of our B2C users, which is $8
What about B2B users?
B2B users, we charge $400 monthly
but the variable cost for B2B users is just $50
Then we can calculate the contribution margin of B2B users, which is $350
Well, a little bit complicated
There are two different contribution margins
Fixed cost is the same as $70,000
That is a fixed cost
Also, we have two different types of contribution margin
based on two different types of users
Contribution margin first from the B2C users is $8
Contribution margin from our B2B private academia, is $350
Anyway, based on this information,
they calculate the breakeven point.
So to break even purely on B2C, if we ignore the B2B users,
we'd need at least 8,750 paying users per month.
But if we had 100 academy clients,
then we can reduce our B2C users from 8,750 to 4,375 users.
This is a calculation of the breakeven point.
B2C alone(purely), we need 8,750 users
But if we had B2B clients, then we need B2C 4,375
or if we have just only B2B only, then we need 200 clients
and we don't need any B2C users
Now you understand the relationship when you calculate the breakeven point from
the subscription business model
This is how we use breakeven point
What do you think? Is it helpful?
You know, finance is very important
and accounting is also important
We should know how to use our accounting report
Also, how to deal with our numbers
Remember, breakeven point is very important
because investors really care about your breakeven point
So you need to prepare the numbers
for your investors and for yourself
Thank you for listening