Break-even analysis

In one paragraph

Break-even is the number of sales at which money coming in exactly covers money going out. Below it you are losing; above it you are making.

Costs split into two kinds. Fixed costs do not change with how much you sell — rent, insurance, salaries. Variable costs rise with each unit — materials, packaging, the labour in the item itself.

Contribution per unit is the selling price minus the variable cost of one unit. It is what each sale contributes towards the fixed costs.

Break-even point (units) = fixed costs ÷ contribution per unit

If fixed costs are £20,000, the item sells for £25 and costs £15 to make, contribution is £10 and break-even is 2,000 units.

Margin of safety

The margin of safety is how far current sales sit above break-even — the amount sales could fall before you are losing money. It is the number that actually tells you how exposed you are, and it is usually the more useful of the two.

How to actually use it

• Work out your own break-even honestly, including the wages of everyone whose time is not billed. Most owners have never done it and are surprised.
• Use it to test a price change before you make it. A 10% price cut usually needs a far larger volume increase than people expect, because it comes straight off contribution.
• Our calculator does the arithmetic: /tools/break-even-calculator

Where it breaks down

• It assumes you sell one thing at one price with a constant variable cost. Real businesses sell a mix, and the answer shifts with the mix.
• It assumes everything you make is sold, and that fixed costs stay fixed. Grow enough and you need another van, another oven, another person — fixed costs step up.

If you are being examined on it

Show the formula, show the working, then say what the number means for this business. Marks are lost by calculating correctly and never interpreting.

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