Copyright © 1996, The Enterprise Foundation, Inc. All rights reserved.

Adaptation of this
material is permitted only for noncommercial purposes.

Guide to Breakeven Analysis

for Nonprofit Organizations
Purposes of Breakeven Analysis
Breakeven analysis is a method used to forecast whether a specific business
activity or group of activities will be profitable. It is typically used in conjunction
with business planning and cash flow projections.

One might ask, what is the relevance to nonprofit organizations, which are not
organized to make a profit? The question itself contains an erroneous
assumption. Nonprofits can indeed make a profit. The profits simply cannot
benefit an individual (such as a shareholder in a for-profit corporation) and must
be reinvested.

Smaller-scale nonprofits and some of their funders are reluctant to take the view
that profits—or generation of new capital—are proper goals for nonprofits.

But the reality is that nonprofits engage in many business activities—in the fields
of health care, residential care, publishing, housing, education, social services
and many others. If one of these public-purpose businesses intended only to
break even or take a loss, it would most likely stagnate of fail, since no capital
would be generated for expansion.

Breakeven analysis can benefit nonprofit organizations in these ways:

• A program planner can use the technique to determine if a proposed activity

with sales, fees or other revenues is financially feasible.
• The technique can be used to analyze any number of “what-if” scenarios, to
determine when they will generate revenue and how much.
• It is a planning tool that can help determine how much core overhead an
organization can support from the revenues of one or more “businesses.”
• Related to the question above, it is a tool to help make tough decisions on
whether certain employees will be considered temporary or permanent.
The last issues involves profound questions for nonprofit groups involved in the
construction or sale of real estate or other activities that may be subject to feast
and famine. Will employees be “carried” or laid off when there is no revenue-
producing work? Or will every effort be made to insure a steady stream of work
and revenue, or at least constructive use of downtime? Or is it better to hire
contract professionals who are paid fees only when the business activity is
occurring.

What is Breakeven Analysis?

Breakeven analysis is generally performed to analyze one or more scenarios of :
(1) a new venture or (2) an existing activity that is not going well. It assumes a
movement—over a period of months or years—from losses or profitability. The
BREAKEVEN POINT for a business is reached when the business is neither
making nor losing money, or in other words when total revenue equals total
costs.

There is an implicit assumption in this analysis—an activity that can move to the
breakeven point will move on to profitability as volumes of business increase and
operations become more efficient.

Breakeven analysis is also called “cost-volume-profit analysis”, because it

examines the relationship between those three factors.

The key question you seek to answer with breakeven analysis is:

At a given level of capital investment and fixed expense, how much

of our product or service do we have to sell to break even?

Nonprofit groups that develop and operate rental housing are familiar with a form
of breakeven analysis, even though it goes by the name of “proforma” or “cash
flow analysis.” A rental housing project loses money when it is first being rented
up. It breaks even at somewhere around 90 percent occupancy. Typically at 95
percent occupancy, the project makes a profit.

With a project such as this, the breakeven analysis simply involves looking at the
bottom line of the budget for each month or calendar quarter: the net cash flow.
In the month that figure first becomes positive, breakeven is predicted to occur.

In a more technical sense, breakeven analysis is considered “static” analysis,

since the basic financial assumptions are clear and “unmoving” for each point in
time.

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Calculation of Breakeven
There are several methods used to determine the number of sales or other
transactions needed to reach the breakeven point. This is the most basic
method:
1. Calculate the VARIABLE COST of each transaction. For example, for many
nonprofits in the housing field, variable costs are the costs of buying, repairing
and selling housings (or building them)—they are costs that go away if the
activity were to stop for three to four months (which sometimes happens
between projects).
2. Subtract the variable cost of each item from the sales price to arrive at a
gross profit margin per item. This is called the CONTRIBUTION MARGIN—
the amount that each item sold contributes to profitability.
3. Then divide the total FIXED COSTS by the contribution margin to determine
the number of items you must sell to cover all your costs. Again, using the
example of a nonprofit selling homes, fixed costs are basic operating costs
attributable to selling homes—some, for example, being the costs of office
space and home sales staff. Naturally, in an operation totally dedicated to
fixing and selling homes, ALL administrative costs would be fixed costs.

The mathematics look like this:

Step 1: SALES PRICE – VARIABLE COST PER ITEM = CONTRIBUTION

MARGIN

Step 2: FIXED COSTS

CONTRIBUTION MARGIN = # ITEMS REQUIRED

For example, your organization is building and selling homes. Your office and
administrative costs are $150,000 a year. The VARIABLE COST of building a
home averages $70,000. The SALES PRICE averages $75,000. Each time you
sell a home, you clear $5,000 in gross profit (the contribution margin).

Now, being a nonprofit, things are not quite as clear as with a for-profit business
—you receive $100,000 a year in grant funding, leaving $50,000 in overhead that
you hope to recover from profits of home sales, so your relevant FIXED COSTS
are only $50,000. When that $50,000 is divided by the contribution margin of
$5,000, you find that you need to sell 10 homes a year to break even.

Breakeven analysis can apply to many potential and existing activities of

nonprofit groups—as long as a fee or a price is involved. Many nonprofits are
paid fees by third parties (such as local government) every time a home is sold or
a service (such as counseling a client) is performed. Those fees make up the
contribution margin or add to it if other revenue is involved.

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Defining Variable and Fixed Costs
Sometimes the most difficult part of breakeven analysis is determining the
difference between variable and fixed costs.

Variable costs:
• Are costs of buying or manufacturing or delivering your product or service
• Are only incurred when you produce sales of your product or service, directly
related to production
• Include costs of employees hired temporarily and only to deliver the product
or service
• Are often described by accountants as ‘direct” costs

Fixed operating costs:

• Are costs you incur at fixed levels regardless of the amount of product you
produce or deliver
• Are incurred on a regular basis though the amount may vary from month to
month
• Are often described by accountants as “indirect” costs or “overhead”

Some costs can be categorized based on the organization’s goals and intentions.
For example, wages of construction workers would be considered variable costs
if they are hired only when needed and laid off when not needed. But if the
intention is to keep them on steadily and always find work for them, their costs
should be considered fixed.

Costs associated with some items can have components of both fixed and
variable costs. For example, leasing cost (or depreciation and interest cost) of a
vehicle used by a construction crew will likely be fixed. Gasoline cost varies
according to your level of production activity.

On the surface, breakeven analysis might seem so simple that one could do it
mentally. But if it is being done well, that is not so. A good breakeven analysis
estimates every possible expense that varies with production. Unless this is
done, an activity that appears sound and profitable may really be losing money
for the organization.

The following lists may help identify both the obvious and “hidden” variable costs,
as distinguished from fixed costs.

Typical Variable Costs

Costs of goods bought and sold

Real estate acquisition and construction costs

Fees and other soft costs related to real estate transactions

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Loan interest and other carrying costs

Extra costs related only to production:

Delivery/mail/postage
Long distance calls, fax costs
Vehicle fuel and service
Mileage allowances
Production supplies
Tool purchases and repairs
Uniforms/laundry/refreshments/other employee related costs

Commissions for sales

Insurance premiums pegged to construction or production volumes:

Added liability premiums
Added workmen’s compensation premiums

Wages for temporary employees, and fringe costs:

FICA
Federal and state unemployment taxes
Disability and life insurance
Payments to retirement plans
Health insurance
(Do not forget to add wage and fringe costs for holidays, vacations, and
downtime—over and above time on the job)

Typical Fixed Costs

Office rent

Fixed premiums of insurance policies

Utilities

Cleaning

Office supplies

Maintenance

Telephone, base charges

Vehicle leasing

Advertising

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Licenses/Fees

Wages/salaries and fringe benefits for permanent employees:

FICA
Federal and state unemployment taxes
Disability and life insurance
Payments to retirement plans
Health insurance

Interest paid on mortgage loans and business debt

Limitations of Breakeven Analysis

Breakeven analysis has limitations as a financial tool. For example:
• Fixed costs only stay fixed over a limited range of production levels.
Example: if you continuously increase the number of homes you sell, at some
point you will need to increase staffing or contract personnel who manage
construction, counsel and qualify buyers, and sell homes.
• Profitability and the contribution margin can stagnate or decline—particularly
when dealing with low-income clients. Example: Your clients can only afford
$75,000 per home on average—and that depends on heavily subsidized
financing which is increasingly harder to get. But your costs keep creeping
up.

Example of Cash Flow Breakeven Analysis

The breakeven analysis method described above determined only HOW MANY
sales or transactions were needed to break even. Just as important is knowing
WHEN the activity will break even. To determine this, a cash flow analysis is
needed.

A cash flow analysis is a forecast of expected transactions, revenues and

disbursements over periods of time. This is an example:

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 Breakeven Cash Flow Analysis for a Nonprofit
Homebuilder

Month 1 Month 2 Month 3 Month 4

Construction Starts 1 2 2 2
Home Sales 0 0 1 2
CASH AVAILABLE START OF
PERIOD: 0 (7,000) (6,000) (2,000)

CASH INFLOWS:

Grants 10,000 10,000 10,000 10,000

Construction Loans 33,000 66,000 66,000 66,000
Home sales proceeds 0 0 75,000 150,000
Total revenues 42,000 76,000 151,000 226,000

DISBURSEMENTS

Fixed expenses 12,000 12,000 13,000 14.000

Variable expenses:
Construction manager 4,000 4,000 4,000 4,000
Lot purchases 15,000 30,000 30,000 30,000
Construction draws 15,000 30,000 30,000 30,000
Sales commissions 0 0 2,000 4,000
Other development costs 3,000 6,000 6,000 6,000
Loan Principal payments 0 0 68,000 136,000

Total Disbursements 49,000 82,000 153,000 224,000

CASH AVAILABLE END OF (7,000) (6,000) (2,000) 2,000

PERIOD (DEFICIT)

In this example, a new nonprofit organization is being formed to build and sell
homes. It is estimated that it can count on an average of $10,000 a month in
grant funding to cover most of its fixed expenses—office, executive director, etc.
—which have been calculated at $12,000 to $14,000 a month (the variations can
be due to insurance and tax payments).

As construction starts up, construction loans are presumed to cover: (1) lot
purchases, (2) construction draws and (3) “other development expenses.” The
$4,000 monthly cost of the construction manager and sales commissions is
assumed to be paid of out other sources—grants or profits from home sales.

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The breakeven point is reached in Month 4, with indications that the activity
cannot only continue to cover the shortfall for fixed expenses but also generate
$2,000 or more in extra revenue each month. Most importantly, the analysis
indicates that the organization MUST build and sell two homes a month to cover
its most critical variable expenses: the cost of the construction manager.

However, $15,000 in losses occur during the start-up period—due almost entirely
to the hiring of the construction manager. There are several strategies for
dealing with this:

• Add this cost into grant proposals for funding the basic overhead of the
organization for that year.
• Seek special one-time grants for the planning and start-up of the project.
• Ask lenders if the construction management costs could be added to financed
construction costs.
• Borrow against expected profits (the most risky scenario).

How are Losses Covered before the Breakeven Point?

The example above raises one of the most critical financial questions for
nonprofits: how will losses of new ventures be earned until the breakeven point
is reached? Unlike many for-profit business, nonprofits do not have revenues to
reinvest in new ventures, or borrowing capacity to cover temporary losses.

The example also illustrates the generic strategies are employed to deal with
losses:

• With real estate development projects the period of losses is almost always
financed—at least in part—with loans, but only if there is a near certainty that
future revenues can repay the loans. In other words, it is common for
construction loans to cover most if not all of the variable costs of a real estate
development project.
• Nonprofits often receive planning grants or unrestricted grants, which can be
used to fund the “r and d” stage of a new activity.
• Some activities may have to reach the breakeven point on Day one—not
through revenues but through subsidies. These may include “soft”
predevelopment loans or grants from cities, housing trust funds, foundations,
etc. Programs that pay for core operating support of nonprofits make this
funding more predictable.

As an example of the last strategy, a nonprofit might be planning to open a

shelter for abused spouses, knowing it will be reimbursed by the state on a per-
client basis starting two months after it opens—since there is a time lag in
payments.

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If the planners did a breakeven analysis, they could identify the total losses
before the project breaks even. Then those expenses could be added to a fund
raising campaign for start-up costs—which might also include the cost of the
building, repairs, furniture and equipment.

Source: Adapted by Peter Werwath (1995) from “Business Planning for Nonprofit
Housing Organizations,” a training manual developed by The Enterprise
Foundation and ICF, Inc., 1992.