Break-Even Analysis: The One Number Every Owner Should Know
Most owners I work with know last month's profit but cannot say at what level of sales they would neither profit nor lose. This explains how that number is calculated, what it assumes, and how to use it in real decisions — pricing, accepting an order, adding capacity, and negotiating a discount.
Three concepts to keep apart
Fixed costs do not change with volume within a given range: rent, salaried staff, insurance, depreciation, software. Variable costs move directly with units: raw materials, piece-rate labour, packaging, sales commission, freight.
Between them sit semi-variable costs such as an electricity bill with both a standing and a production-driven element. The simplest practical split is the high-low method: take the cost difference between your highest- and lowest-volume months and divide by the volume difference to get the variable rate per unit; the remainder is fixed.
Contribution margin is the heart of the analysis: selling price per unit less variable cost per unit. It tells you how much each sale contributes towards covering fixed costs. It is not the same as gross margin — gross margin also absorbs fixed production costs such as machine depreciation and supervisor salaries.
The formulas
- Contribution margin per unit = price − variable cost per unit
- Contribution margin ratio = contribution margin ÷ price
- Break-even (units) = total fixed costs ÷ contribution margin per unit
- Break-even (revenue) = total fixed costs ÷ contribution margin ratio
- Sales for a target profit = (fixed costs + target profit) ÷ contribution margin per unit
A worked example
| Item | Amount (monthly) |
|---|---|
| Selling price per unit | 850 |
| Materials per unit | 420 |
| Direct labour and packaging per unit | 130 |
| Contribution margin per unit | 300 |
| Contribution margin ratio | 35% |
| Rent and service charge | 35,000 |
| Salaries and social security | 60,000 |
| Depreciation | 15,000 |
| Other fixed costs | 10,000 |
| Total fixed costs | 120,000 |
Break-even in units: 120,000 ÷ 300 = 400 units per month. In revenue: 120,000 ÷ 0.35 ≈ 340,000 per month. For a target profit of 60,000: (120,000 + 60,000) ÷ 300 = 600 units.
Margin of safety
If actual sales are 500 units, the margin of safety is 100 units, or 20% — sales can fall by a fifth before you are loss-making. Below about 15%, in a business with heavy fixed costs, that is a warning.
The larger the fixed share of your cost base, the more sensitive profit is to sales swings. A workshop with heavy machinery earns more in a good year and reaches losses faster in a downturn — the starting point for cost management in a downturn.
Cash break-even
Accounting break-even tells you when you stop making a loss. Cash break-even tells you when you stop running short. To get it: remove depreciation from fixed costs, add repayments of loan principal, and include tax and insurance actually paid in the month.
In the example: 120,000 − 15,000 = 105,000, plus 30,000 of monthly instalments = 135,000. Cash break-even = 135,000 ÷ 300 = 450 units. Between 400 and 450 units this workshop shows a profit on paper and still runs short in the bank. That gap is the source of most "we are profitable but we have no money" complaints — see cash flow and working capital.
Multiple products
Calculate each product's contribution margin, then weight by sales share:
| Product | Share of sales | CM ratio | Weighted |
|---|---|---|---|
| A | 50% | 40% | 20% |
| B | 30% | 30% | 9% |
| C | 20% | 15% | 3% |
| Weighted average | 100% | — | 32% |
If the mix shifts towards C, break-even rises even with total revenue unchanged. That is why margin analysis by product is the necessary companion to this calculation.
Where it changes decisions
- Accepting a low-priced order. With spare capacity and fixed costs already committed, any order with a positive contribution margin helps — but only temporarily and only for genuinely idle capacity.
- Granting a discount. At a 35% contribution margin ratio, a 10% price cut needs roughly a 40% volume increase to hold profit flat. That number usually ends the negotiation.
- Adding fixed cost. A new hire or a second warehouse raises break-even; calculate the extra sales needed before committing.
- Pricing. Variable cost is your floor, not full cost — but a sustainable price must also carry its share of fixed costs. See product pricing.
The most common error I see is leaving the owner's salary out of fixed costs. A business whose owner works full time for nothing has a real break-even point far above the one on the spreadsheet.
Limits of the model
The assumptions are simplifications: constant price, constant variable cost per unit, stable sales mix, and a clean fixed-variable split. Fixed costs are only fixed within a relevant range — double production and you need another warehouse and another supervisor, and the cost steps up. Under inflation the biggest risk is using historical material cost instead of replacement cost, which is covered in production costing. Recalculate quarterly, not annually.
Key takeaways
- Break-even is fixed costs divided by contribution margin; the split of fixed and variable costs decides the answer.
- Cash break-even — depreciation out, loan principal in — is the number that matters under liquidity pressure.
- Margin of safety shows how far sales can fall before losses; under 15% is a warning.
- In a multi-product business, a change in sales mix alone moves the break-even point.
- Include the owner's salary and refresh the figures each quarter under inflation.
Frequently asked questions
How is the break-even point calculated?
What is the difference between accounting and cash break-even?
How does this work with multiple products?
Should the owner's salary be treated as a fixed cost?
Does VAT belong in the calculation?
Have a question? Just ask
One short call is usually enough to know where you stand. If I miss you, I will call back.